Presentation to a Reserve Bank Seminar, 16 March, 2006
Keywords: Globalisation & Trade;
Introduction
Later this year Auckland University Press is to publish my book Globalisation and the Wealth of Nations, which is the result of a project supported by a Marsden Fund Grant. It is a big book, as befits the project, so I must be selective. After describing the general thesis of the book, and quickly running through its contents to give a sense of its scope, I will focus on the part which gives the long term prognosis.
I was asked to comment on the policy implications of the study. If it has any, it is to extend the policy framework rather than to advocate specific policies. Policy frameworks do not alter rapidly. I have no expectation that what I am about to tell you now will soon enter policy thinking. Instead I will mention various ways in which the study has affected my thinking.
I want to assure you that the model I am going to use is very orthodox. It has been developing for about twenty-five years and will in due course be awarded a Nobel prize. For those unfamiliar with the model, some of its conclusions may seem startling, contradicting widely held beliefs. That is because the theory is exploring situations in economics which have previously been ignored as too hard, the most important of which are industry economies of scale.
Prologue
In the nineteenth century a vigorous debate took place among those who disliked the trends of the day – trends which they thought of as ‘industrialisation’,but which we now see as the early stage of globalisation.
The French anarchist, Pierre-Joseph Proudhon, appalled by the human costs of industrialisation, argued for a reversion to a rural way of life which preceded the early globalisation, with a nostalgia for an Arcadia which never existed, but which he hoped could be recreated.
Was there an alternative to retreat? Does the world have to surrender to the forces of globalisation with its dark satanic mills and toiling the fields?
The best-known alternative to Proudhon came from Karl Marx, who argued that industrialisation was essentially a progressive – if unrelenting – force even though it caused misery to the worker caught up in the transformation. But, Marx went on to argue, ultimately the outcome would benefit workers with the creation of a state in which they would enjoy the fruits of their labour.
With hindsight we can see that Marx was broadly correct. Sure, we have not reached any ‘communist’ state: Marx himself was a bit vague about what he meant by it. But ultimately the workers of the world are better off with industrialisation. Had they retreated to the nostalgia of Proudhon’s Arcadia, they would not be, for they would be isolated from the benefits of the technology which drove globalisation and industrialisation. Admittedly there has not been much equity in the sharing of the fruits of the transformation. Among those who have benefited least were those in the Africa but, even so, their material standard of living is still about three times higher today than it was a couple of hundred years ago.
So the challenge is not how to stop globalisation. Rather it is how to harness it for the common good. That was the challenge our nineteenth-century ancestors took up, despite the awful effects of industrialisation. As a result we live in a much more benign society than they did. (Thankyou ancestors.) That is the challenge and the prospect for this bout of globalisation too. To harness the forces of globalisation, rather than to deny them or pretend we can reverse them.
Marx’s last thesis on Feuerbach famously concludes ‘philosophers have only interpreted the world in various ways; the point is, to change it.’ The first task is to understand it.
The Book’s Thesis
The book’s analysis is based on five propositions:
1. Globalisation is the economic integration of economies – regional and national economies.
In recent years economists have converged on a common definition, although the one used here is slightly wider because it includes regional economies as well as national economies. From a historical perspective, the integration of nations was preceded by the integration of regions.
2. Globalisation is caused by the falling cost of distance
Globalisation requires an understanding of space. In economics space is connected by the costs of distance, including transport costs, the costs of storage, security and insurance, information transfer, timeliness and the lack of intimacy. It has been calculated that the average American manufacture worth $100 at the factory door sells in America for $155 and overseas for $270 after the costs of distance are added. The study attributes about a third of the export trade costs to transport costs. The other two thirds are due to border-related barriers – language barriers, currency barriers, information barriers, contracting costs and insecurity, and policy barriers. Policy barriers (tariffs) contribute only about a seventh of export trade costs.
In the last 200 years trade costs have fallen dramatically, although they are difficult to illustrate except by example. Time is easier to report. Travel time between New Zealand and England has fallen dramatically over the last 150 years. In the middle of the nineteenth century it took a boat three to four months to sail from New Zealand to England. Today a ship can do the trip in three to four weeks.
That underestimates the reduction. Today, near a fifth of New Zealand’s merchandise exports and imports are airfreighted today. Most people fly. It takes just over a day to fly to England. Information travels even faster. It can be electronically transferred between New Zealand and England almost instantaneously.
We live in a very different world from that which our ancestors did. Yet we think in terms of their world. Most New Zealanders are not aware that our second to largest external port by freight value is Auckland International Airport. Tourism is on top of that. It may be one day the biggest export port will be our international broadband connection.
3. Globalisation has exceptionally powerful effects when the reduced costs of distance combine with economies of scale.
Economists often assume that producing more requires an increasingly greater effort, a notion captured in the phrase ‘diminishing returns’ and signalled by rising unit (or average) costs as output increases (in a particular period).
However, over some ranges of production, unit costs may fall. The reasons for such economies of scale are varied and include indivisible inputs (a machine costs the same whether it produces a single item or many); startup costs; learning effects; specialisation; the economies of increased dimensions; greater use of flow production over batch production; relatively smaller inventories; the division of labour.
Economies of scale generate some deep analytic problems for economists for the standard account of competitive markets does not work properly. Of course markets work, producing and distributing products, but the desirable properties that they do so efficiently may no longer apply.
For our purposes falling costs of distance enable economies of scale to be reaped. The theory is superbly developed in The Spatial Economy: Cities, Regions, and International Trade by Masahisa Fujita, Krugman and Tony Venables
A quick intuition may be useful. Suppose steel mills have enormous economies of scale, so that the unit cost for large production is very much lower than when production is small. If costs of distance are high, the mill’s market may be local and very small, so small that no steel is produced and the locality – all localities – have no access to cheap steel. Suppose the costs of distance fall. In which case the potential market increases, and it is now commercially viable to supply it from one large plant. A whole range of uses – many hitherto unknown – appear. The forces unleashed may be powerful, dynamic and transforming.
The outcomes are unusual. Not only can the location of the industrial plant with large economies of scale be indeterminate but, as we I shall see, the mathematical model suggests there may be two development paths: a rich one where the economy benefits from economies of scale, a poor one where it does not, with hardly any countries in between. It suggests a very powerful account of the past development of the world economy and an extraordinary – and yet plausible – suggestion of how it may develop in the future.
4. Globalisation became important in the early nineteenth century, so the phenomenon is almost two centuries old.
There is much argument as to when the processes of globalisation began. The book considers whether it started as early as the fifteenth century precipitated by the fall of Constantinople in 1453, Dias rounding the Cape of Good Hope in 1488, Columbus crossing the Atlantic in 1492. Critically, the Chinese gave up exploring the the world in 1433, cutting them off from the challenge of the foreign. Perhaps the most significant event in the fifteenth century was Gutenberg introducing the printing press. Now information could be globalised – moved long distances relatively cheaply.
As attractive as is the fifteenth-century date for the start of globalisation, the costs of distance remained high and interactions between regions were small. Even at the beginning of the nineteenth century, goods exports made up only about 1 percent of the world’s production (GDP). While there were globalisation forces, it is hard to argue they were powerful.
By the end of the nineteenth century the world’s exports were just above 7 percent of production (and global production itself had increased by over 6 times too – so exports increased by almost 50 times during the century). Today merchandise exports are nearing 20 percent of total production and there are also exports of services. Globalisation became powerful at some time in the early part of the nineteenth century.
5. Globalisation is not solely an economic phenomenon in a historical and geographical context. It has political and social consequences. In particular
– it impacts on, but does not eliminate, cultural differences and
– it reduces, but does not eliminate, the policy discretion which nation-states have.
The Structure of the Book
Diminishing Distance
Chapter 1: The Analytics of Globalisation
Chapter 2: The Significance of Location:
Chapter 3: When Distance Changed:
Chapter 4: Regional Integration and Plant Economies of Scale:
Chapter 5: The Forces of Agglomeration
Chapter 6: The Indeterminancy of Location:
Chapter 7: When Services Become Tradeables:
Chapter 8: Intra-Industry Trade:
Chapter 9: Migration:
Chapter 10: The World’s Population
The first eight chapters demonstrate the importance of location. After the opening chapter on the analytics of globalisation, Chapter 2 shows how political and social relations were transformed in Polynesia when it connected with the rest of the world from the end of the eighteenth century.
The following more-economic chapter tells the same story illustrated by the falling cost of distance for transporting meat from prohibitive to negligible with the introduction of refrigeration. The underlying model is standard international trade one, with two additions. First, the resulting pastoral and processing industries become technologically innovative, and second the new industry transforms political and social life in New Zealand.
The same story is told again in Chapter 4 with the addition of plant economies of scale. The US was transformed from a minor manufacturer at the beginning of the nineteenth century to the world’s greatest at the end. A couple of lessons here,. First, the illustration is about regional, not international trade – recall my definition of globalisation. Second, the US was able to reap the benefits of economies of scale because there were no trade barriers between states, while labour and capital could flow to where they were most productive.
Chapter 5 is about economies of agglomeration – economies of scale of industries rather than plants – and how they explain centres of high economic activity in cities, such as New York. That is why the New Zealand government is getting closely involved in the reform of the governance of Auckland. Without a vibrant Auckland we cannot get the economies of scale that New Zealand needs.
Economies of scale can be so strong that the location of a firm or industry can be almost accidental, illustrated in Chapter 6 by Nokia. There is no necessary reason why the world’s most successful mobile phone company should be based in Finland. It was an accident. Sometimes we may not be able force a particular industry to locate in New Zealand, but we should ensure that we have a favourable economic environment when serendipity creates the opportunity.
Chapter 7 points out that some services we once thought had to be located near the customer, can be located in cyberspace. That means we need to be concerned with the quality of our broadband connections with the world, while broadband based service exports are likely to flourish.
Globalisation was associated with the shift from the dominance of trade based on absolute advantage – spices for silver – to trade based on comparative advantage – wine for cloth. Chapter 8 draws attention to, how recently, an increasing portion of international trade has been based on competitive advantage, where two countries trade similar products. It is a major source of domestic dynamism as the exporters apply what they learned from foreign markets to their home. An important source of intra-industry trade is the supply chain of components made in many countries and assembled in another. New Zealand has one of the lowest proportions of intra-industry trade among rich countries and is hardly involved in supply chains. Changing that is crucial if we want to ‘transform the economy’.
The final two chapters in this section are about migration, which today is at a lower relative level than it was in the nineteenth century, because nation-states restrict the movement of labour. Trade is a(n imperfect) substitute for labour mobility, and does not address those products which cannot be traded, based on the land or non-tradeable services. The aging of the population will force a higher level of migration – including low skilled migration – than is currently assumed by the UN forecasts. This applies to all Rich Countries, including New Zealand. Migration is a policy issue we have yet to address.
The Nation-State and Diminishing Distance
Chapter 11: Sovereignty:
Chapter 12: Nationalism:
Chapter 13: Cultural Convergence:
Chapter 14: Diasporas:
Chapter 15: The Social Market Economy:
Chapter 16: Is Policy Convergence Inevitable?:
Chapter 17: World Trading Arrangements:
Chapter 18: The World Financial System:
Chapter 19: Foreign Direct Investment:
The next section of the book explores the notion of the nation-state. I wont develop the argument here. But the section concludes that despite the diminishing costs of distance and associated globalisation, there seems likely to remain a role for the nation-state in a confederated world of nations, although it will have less commercial sovereignty than we are used to.
Economic Development
Chapter 20: How Economies Develop
Chapter 21: Resources:
Chapter 22: Information:
Chapter 23: Technology Transfer:
The third section of the book looks at some of the issues in the process of economic development. I describe briefly some policy issues which come from them.
Those familiar with my thinking will not be surprised that I focus on technology as the driver of economic development. I am relatively optimistic that we should be able to find technological substitutes for the exhausted oil reserves, although there may be a period of economic stagnation as the more resource intensive alternatives cut in. I am more pessimistic about the world’s ability to find sustainable political (commercial governance) solutions to other resources, including sea-fish, water and global warming. New Zealand has governance advantages in sea-fish and water. We are not doing enough to exploit them.
To the nearest percentage, 100 per cent of the world’s technology is produced outside New Zealand. While domestic technology generation is important, technology transfer from overseas is all important. Yet our policy rhetoric emphasises local technology creation and ignores technology transfer. Fortunately our technology practices are not so stupid.
How the World Economy Developed.
Chapter 24: The Rich Club:
Chapter 25: The Poor Club:
Chapter 26: Why There is No Significant Middle Club
Chapter 27: The Pattern of World Development:
I shall spend the rest of the paper describing the fourth section of the book. Here are some interesting facts to be incorporated in any theory of world economic development.
Some Facts About World Economic Development
The first is that there is a group of rich countries, which persistently remain rich. A hundred years ago Western Europe, the US, Canada, and Australasia had markedly higher incomes than the rest of the world. They still do today. The ‘Rich Club’ is not exclusive. In recent decades its membership has been extended to include Japan, Ireland and Spain. Others may join soon.
The persistence of membership of the Rich Club contrasts with the transience of corporations. There would be few common members on a list of the top 30 international corporations of today and that of a hundred or even fifty years ago. As the Maori say ‘Only the land remains, constant and enduring’.
Economists have identified a ‘convergence’ process. Those members of the club which are laggards tend to catch up with those at the top, it being easier to catch up with the leaders, than to get ahead of them. Once an economy has caught up, it strains with the rest of them to stay near the front. Japan from about 1990 and Ireland from about 2000 are examples of this struggle.
The mechanism which keeps the rich getting richer – this clustering and the convergence – is the international transfer of technology. Membership of the Rich Club is characterised by countries which are able to rapidly adopt the most productive technologies.
While persistence of membership is characteristic of the Rich Club of nations, albeit with new members joining, there are two countries which fell out of it. A hundred years ago Argentina and Uruguay were up with the leaders. They are not there now.
Others have struggled to stay there. The next two on the slow growth list are Australia and New Zealand. At the beginning of the twentieth century they had markedly higher incomes than average and their growth retardation has been less than the Latin American pair, so they remain members. While the four countries are characterised by being settler colonies, so are Canada and the US who have not experienced as slow growth. What the four have also in common is they are all farm exporters.
The book argues that deteriorating terms of trade for farm exports caused the slower growth. Those familiar with my In Stormy Seas will know the analysis, so I wont repeat it here other than to say that if a country (or a business) is getting lower prices for its exports (or its products) it is going to be struggling,
Paul Krugman famously remarked that ‘Productivity isn’t everything, but in the long-run it is almost everything.’ He is wrong, insofar as the statement ignores that changes in relative prices matter too. In the model I am about to describe – ironically, Krugman is one of its authors – relative prices change with long-run implications.
Second, poor countries have benefited from globalisation too. While average incomes has increased nine times in the last two hundred years (after increasing about 50 percent in the previous 1800 years), not all countries experienced the same increase. The following table summarised the regional dispersion.
Income Changes in the last 200 Years
<> REGION
<>2000 income
relative to 1800
<>GDP per capita
$1990
<>Percent of
World Population
<>1820
<> 1998
<>1820
<>1998
<>Australasia
<>45.9
<>753
<>20,082
<>0.1
<> 0.9
<>United States
<>38.5
<>1,257
<>27,331
<>1.0
<> 4.6
<>Japan
<>33.4
<>669
<>20,413
<>3.0
<> 2.1
<>Western Europe
<>17.1
<>1,232
<>17,921
<>12.8
<> 6.6
<>Latin America
<> 9.8
<>665
<> 5,796
<>2.0
<> 8.6
<>Eastern Europe
<> 9.6
<>636
<> 5,461
<>3.5
<> 2.0
<>WORLD
<> 9.3
<>667
<> 5,709
<>100.0
<>100.0
<>Other Asia
<> 6.6
<>565
<> 3,734
<>8.6
<> 19.8
<>Former USSR
<> 6.3
<>689
<> 3,893
<>5.3
<> 4.9
<>China
<> 5.0
<>600
<> 3,117
<>36.6
<> 21.0
<>Africa
<> 3.4
<>400
<> 1,368
<>7.1
<> 12.9
<>India
<> 3.2
<>550
<> 1,746
<>20.1
<> 16.5
So while World per capita income grew 9 times, Rich Club members experienced a 30 times increase, and the poorest regions grew between 3 and 6 times. Given that there was hardly any income growth in the previous two millennia, globalisation was some benefit.
Suppose two hundred years ago, you were given the choice between a continuation of the previous two thousand years of stagnation, or economic growth from globalisation, but you did not know which region you would be in – whether it will be a fast growth or slow growth region. Most people behind a veil of ignorance would have chosen globalisation: the worst that could happen is to be in a region whose per capita output was only three times higher after the two hundred years.
Even so, there is a curiosity here. One might have thought economic theory would predict that poor countries would grow faster than rich countries. because the low wages ought to attract investment, and produce cheaper goods which undercut the Rich. Why is that not happening?
Third, the history of manufacturing also poses a challenge. As the next table shows, the two biggest manufacturing economies in the world in 1750 were China and India.
Manufacturing Output (By World Share: Percent) 1750-1938
<>
<>1750
<>1800
<>1860
<>1913
<>1938
<>Britain
<> 1.9
<> 4.3
<>19.9
<>13.6
<>)
)
) 92.8
)
)
<>Other Europe
<>21.3
<>25.8
<>33.3
<>43.0
<>US & Canada
<> 0.1
<> 0.8
<> 7.5
<>32.9
<>Japan
<> 3.8
<> 3.5
<> 2.6
<> 2.7
<>China
<>32.8
<>33.3
<>19.7
<> 3.6
<> 3.1
<>India
<>24.5
<>19.7
<> 8.6
<> 1.4
<> 2.4
<>Other
<>15.6
<>12.6
<> 8.4
<> 2.8
<> 1.7
In the eighteenth century China and India made up about 55 percent of the world’s population, and they produced about 55 percent of the world’s manufactures. Yet in 1938 the ‘developed core’, with 23 percent of the world’s population produced 93 percent of all manufactures. China and India hardly produced anything.
Why the concentration in a (relatively) few countries? Earlier chapters explained that given strong industry economies of scale, manufacturing ends up in particular locations if the costs of distance allow. But that does not explain which location. If economies of scale are so important, why has manufacturing not been located in the two biggest and densest populations: China and India?
That leads to the fourth fact. There are few Middle Income Countries. The world income distribution by country is peculiar In comparison with most income distributions. While they are rarely symmetrical – the rich tend to be much further from the middle than the poor – they tend to have a single peak – a mode – in the middle with most clustering around it, like an inverted U. In contrast, as the following table shows, the world income distribution by countries is characterised as having two modes, a sort of lopsided M but with a big peak at the lower mode, a smaller peak at the higher one. and not much in the middle.
World Income Distribution by Country: 1998 (Micro-states not included in country count)
<>Income Range
(1990 international prices)
<>Countries
<>Percentage of World by
<>Population
<>GDP
<>$14,000-$28,000 (Rich Club)
<> 23
<>14.5
<>54.6
<>$7000-$14,000 (Middle Income Club)
<> 19
<> 3.7
<> 6.6
<>$0-$7000 (Just out Of Poor Club)
<> 138
<>81.9
<>28.8
What is instructive about this categorisation – other than just how many are in the lowest groups – is how small is the Middle Income Club.It has 19 relatively small countries. Seven are dependent upon oil and eight are on the fringes of Rich Club economies. The remainder are the Argentina, Chile, Uruguay, Mauritius and Malaysia. The Middle Income Club is not a large community. It is this sparsity which gives the M-shaped distribution.
The challenge is not to explain why country X or Y is in the Middle Income Club but why so few are there. Why is there a lop-sided M-shaped distribution and not an inverted U.
We have two broad options to explain a bimodal distribution. One is to assume that there are different mechanisms generating the two peaks. Conventional economic analysis tends to follow this approach, saying one set of economies have a certain set of conditions which enable them to be rich and another have another set of conditions that keep them poor. The difference is so strong that it is usual to treat the two clusters quite separately.
The Bifurcation Model
The book sets out the objections to the two development mechanism approach and instead seeks a single mechanism which generates what mathematicians call a ‘bifurcation’ in which the elements of the system go down one of two paths. Such bifurcations are more common than we normally think. Knock a bottle on the edge of a table. What happens remains under the same laws of physics, but the outcome will be very different if the bottle stays on the table or falls off.
Fujita, Krugman and Venables provide an explanation of how we can get two paths, one of manufacturing development (the Rich Club) and one of agricultural development (the Poor Club). Their model is not easy, but it goes like this.
Consider an entire world consisting of just two economies, which are identical in every way: the same population and labour force, the same capital and land, the same technologies and the same patterns of demand. In which case they will have the same levels of sectoral production and consumption, and there is no need for them to trade – so it would seem. Suppose the economies have but two sectors. The agricultural sector has diminishing returns because the quantity of land is fixed, so that average labour productivity falls as more workers work on farms However, the manufacturing sector has increasing returns to scale, so that labour productivity rises as additional workers work in factories.
Initially, there is no trade between the two economies and the production level in each sector is the same, because they are mirror images of one another.
Suppose the cost of distance falls, so that trade is possible. That requires specialisation. One economy produces all the manufactures, drawing workers from its land, and trading its surplus manufactures for the farm products it needs from the other economy. The manufacturing economy also produces some farm products but its farmers are relatively productive.
The other economy specialises solely in agricultural products for it cannot compete with the other’s manufacturers because it has not the economies of scale. Instead it sells its surplus agricultural products using the proceeds to purchase manufactures.
The economy that specialises in manufacturing will have higher incomes than the one which specialises in agriculture. Its manufacturing is benefiting from the economies of scale, while its agriculture production has higher labour productivity with fewer workers on the land.
The farm specialist economy, with all its workers are on the land, has a much lower productivity. Even though they started off identically, the two economies have now embarked upon different development paths. But the two paths are intimately linked by trade. The Rich Club needs to export manufactures to the Poor Club, which perforce cannot reap those economies of scale and the high productivity and incomes.
So when the costs of distance are low enough, there is international specialisation and trade, but given economies of scale the two economies do not benefit equally.
How robust is the model? There are so many assumptions, we cannot examine every one. Technological change can be readily added without distorting the bifurcation and two paths.
How about having only two countries? Adding a third country introduces further possible paths but they do not hover in a Middle Club. Rather the third country can start off in the Poor Club and peel off to join the Rich Club, leaving the other behind as has happened to Japan.
There is a parallel for only two countries. If the costs of distance are sufficiently low, the wages of those in the Poor Club are so low that its factories can undercut the Rich Club manufacturers. The wages in the Rich Club fall and those in the Poor Club rise. The process continues until they are equal for the two economies. The two economies return to producing the same level of manufactures and farm products. The bifurcation ends and the two development paths rejoin. That has not happened yet, but the bifurcation model seems to explain what has happened so far.
The Nineteenth Century’s Great Bifurcation
The differences between the economies of the world in 1800 were not great. A century later the world had divided into a Rich Club and a Poor Club with very few in between. It is tempting to see the nineteenth century as one dominated by the sort of processes which underpin the bifurcation model. As the costs of distance fell the world economy reached the bifurcation point where manufacturing tended to be concentrated in a few locations with the rest of the world specialising in farming.
Why did manufacturing concentrate in Western Europe and the North America? The bifurcation model offers no explanation. Here are two very differing accounts of why the West might have been favoured: an economic one and a political one.
Here is the benevolent (economists’) story. The ‘West’ wasbetter placed to seize the opportunity the falling costs of distance presented. was already slightly richer. Its social, political and commercial conditions were better. It had a stronger record of science. After three hundred years of exploration, it was more open to new ideas. Technology was not as mobile as it is today, so that its discoverers were able to benefit exclusively from it longer. Manufacturing concentrated in the West. However, the economic growth of the West spilled over through trade and technological transfer to other countries, whose incomes also rose, but by not as much.
Here the malevolent (political scientists’) story. Alternatively one might more see politics in the West’s supremacy. Its exploration, with its commercial reach and empires had encompassed the world by 1800, giving it political (and technological) dominance, It used this dominance to shape the World economy in its favour, limiting opportunities for economic development of the colonies and neo-colonies.
We have here two quite separate accounts of why manufacturing located in the West in the nineteenth century. One says it was because of its better technological preparedness industries and the rest of the world benefited: the other says the rest of the world suffered. because of the West’s political dominance. I’ll leave you to choose between them.
The bifurcation did not happen instantaneously. Throughout the nineteenth century the powerful forces of agglomeration concentrated manufacturing into Western Europe and the East of North America.. Regions on their periphery later became manufacturing centres too, Japan joined in, and regions near Japan began to grow too. Thus the Rich Club. Meanwhile, the rest of the World went down the Poor Club track. Their incomes generally rose, as the Rich Club purchased from them, and as new technologies became available.
What Might the Bifurcation Model Say About the Future?
The bifurcation model predicts that it is likely that further economies will peel off from the Poor Club and join the Rich Club. The book cautiously contemplates various possibilities, but focuses on China (and to a lesser extent, India). Because an interest is wages and incomes, I’ll illustrate it with the Chinese assumption, although its joining the Rich Club will be many decades off.
Chinese manufacturing is successful because its workers are doing the same job as Rich Club workers at a fraction of their cost. Despite the costs of distance, the product is more cheaply sourced offshore. In order to avoid unemployment the Rich Club’s workers in these sectors have had cuts in their wages or new jobs. Many Rich Club wage rates have hardly changed in real terms for up to thirty years. Others are taking major reductions in their fringe benefits.
This need not be all bad news. Not all jobs can be replicated in poor countries. Those Rich World workers who work in sectors which cannot be offshored benefit from cheaper clothes, computers and other goods and services produced offshore. Even those protesting at the loss of pay and conditions, are beneficiaries of the relocation in terms of the goods and services they purchase. They would argue that they are worse off in total, but many Rich Club workers are better off.
The Rich Club challenge is to generate jobs which the Poor Club cannot easily replicate. The Danish company Novo makes a cartridge with which diabetics inject themselves with insulin. It develops its product and perfects the production process in Denmark.. When that is settled – it takes three or four years – the company ships the production equipment to its plants in China and Brazil, while moving onto the next generation product.
The strategy of development in the core and production in the periphery is going to be an increasingly common Rich Club survival strategy. But will it – together with the service industry – generate sufficient (high paid) jobs in the Rich Club? Eventually China and other current Poor Club members can replicate the development activity too. Japan already does – those of European stock have no exclusive ability to innovate and develop new products and processes.
Wages need not necessarily fall in the Rich Club. That depends on the new technologies. Even so it is likely, the Rich Club will experience continuing wage stagnation.
It may seem surprising that increased trade can make some participants worse off. But standard theory assumes that the international trade does not change the terms of trade – the price of exports relative to imports. In the bifurcation model, the price of manufactures falls relative to the price of foodstuffs as manufacturing wages get cut, and peasants leave the land. Thus the key assumption of international trade theory of no terms of trade change does not apply. So food and resource producers will be better off, including possibly some members of the Rich Club.
We may already be seeing the terms of trade turn around, as China’s rapid growth sucks in raw materials and food, driving up their price relative to the manufactures it produces. The twentieth century saw rising relative prices for manufacturers, the twenty-first may seem them fall.
A New World Order?
While it is not inevitable that China will join the Rich Club this century, it is surely inevitable that given a reasonably orderly development of the world, the Rich Club will have more members, some of whom may be as large as China or India. That will make it a very different political world as well as an economic one.
The book’s basic insight is that in a world of high costs of distance, the pattern of economic activity corresponds broadly to where people live. That correspondence also largely applies when the costs of distance are very low. In the transition from high to low costs economic activity concentrates in a few economic centres – the Rich Club – which benefit far more from the economies of scale (and agglomeration) and the correspondence between economic activity and population breaks down.
The transition phase does not end with a snapping together of the paths of the rich and poor countries. Rather its ends as a sequence of poor economies peel off, go through a rapid growth phase, and join the Rich Club. Then some more poor economies go through the same transition.
While by the end of this century, membership of the Rich Club will be wider than it is today, the established members cannot expect their incomes to be substantially higher. Slow or zero growth of their incomes is likely to occur even if technological change continues at its past rate, and innovation offsets resource depletion. Income comes from the production of products multiplied by price. The products which were central to lifting the incomes of the rich – manufactures and relocatable services – are likely to experience falls in their prices relative to those for depletable resources and farm products.
The rise in relative prices of commodities in recent years is usually attributed to the demands of the expanding Chinese economy as their lower paid workers produce manufactures more cheaply. That is precisely the mechanism which the bifurcation model predicts.
It is hard from this perspective to see the United States retaining its political and economic hegemony. The change will occur before the majority of Americans realise it has happened. Britain faced similar difficulties in the twentieth century. Even in the 1960s, when its economy was a fifth of the size of the US, and despite having suffered the debacle of the 1956 Suez invasion, there was a popular sentiment that it was still a world power.
This time, however, the adjustment is likely to be more difficult, for there is no replacement hegemonic power. The Brits eventually acknowledged their more restricted role when they could see that the US was so dominant. A multipolar world of five or more great powers – the US, the European Union, China, India, Japan – each of which can make a major – but not unilateral – difference, is much harder to come to terms with, especially for those who were from the previous (declining) hegemon.
Economics has good explanations of how markets work where there is a dominant monopoly (the hegemonic actor), and of pure competition (in which no individual agent has power). It has some understanding of markets where there is a duopoly (such as the bipolar political world of the American and Soviet nuclear powers). However economist’s accounts of oligopoly – of large firms competing in a market – give indeterminate solutions and have proved far more difficult to analyse – certainly not for want of trying by economists.
A multipolar world is similarly more difficult. It is not just that the possibilities of alliances between the powers are so numerous. Unlike commercial markets there is no overarching agent – the government – to regulate the interplay between competitors. We need to think more about the organisation of a multipolar world.
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