Friday, December 23, 2016

Liberation from the shackles of space

The new book “The Great Convergence” by Richard Baldwin is a contribution to globalization studies, economics of development, and trade economics. I more confidently speak of the former two than of the third but I think that even that could be justified.

There are several aspects of Baldwin’s book that are worth emphasizing. The first is a novel and persuasive way of defining the three historical eras of globalization as made possible successively by the reduced cost of transporting (i) goods, (ii) information, and (iii) people. The story goes as follows. When transportation of goods was perilous and expensive, production and consumption coincided geographically: communities consumed whatever they produced. As we know from even the most developed pre-modern societies like Rome, trade was limited to luxury items and wheat. But Rome was an exception: in most pre-modern societies trade was minimal.

Then came the Industrial Revolution that importantly for our story lowered transportation cost of goods. This made shipment of goods to faraway destinations possible and gave us the first globalization, or the “first unbundling” as Baldwin calls it: goods were produced “here” and consumed “there”.  This also gave us other things that economists take for granted: development as national production of goods through all its stages, trade as consisting of nation A exporting a good to nation B, theory of growth that sees nations advancing from production of food to manufactures. Although Baldwin does not say it, practically all the tools of modem economics are still influenced by the way the first unbundling occurred.

The second unbundling (and the second globalization) comes when the control and coordination of production is done “here” but actual  production of goods is done “there”. Notice the difference: first you unbundle production and consumption, then you unbundle the production itself.  The unbundling of production was made possible thanks to the IT revolution that allowed companies to design and control processes from the center while delocalizing the production to hundreds of units or subcontractors dispersed around the world. These are the famous “global supply chains”. Reduced cost of transportation of information (basically, ability to coordinate and control regardless of distance) is for the second unbundling what reduced cost of shipment was for the first.

A couple of things are worth noticing regarding the second unbundling. First, huge importance of institutions. When globalization was just exports of goods, institutions in the country to which the goods were exported did not matter much: whether institutions “there” were good or bad, the exporters were paid (about) the same.  This is no longer the case with the second unbundling.  When the production is delocalized, the quality of institutions, infrastructure or politics  in the recipient country matters enormously to the center. If designs are stolen, produced goods impounded, travel of people between the center and the offshore location made difficult, the entire production structure of the company collapses. For the center, the quality of institutions in the offshore location becomes  almost as important as the quality of institutions locally.

Second, technological progress in the offshore locations now takes an entirely different hue than in the past. While in the past developing countries  were trying to induce foreign investors to share their know-how, now the center (mother company) has all incentives to make sure the best technology is used because the offshore location has become an integral part of the center’s production chain.  This is an enormous change: rather than begging or incentivizing the rich country’s company to transfer technology, now the owner of that technology is herself keen to transfer to the offshore location as much of it as possible.

The great convergence from which the book takes its title, that is the remarkably fast growth of Asia, can thus be understood to have been made possible by an improvement in institutions and much greater transfer of technological know-how. And with both being directly related to the second unbundling. To put it simply: Asia grew thanks to globalization.

Baldwin’s story here clearly links with development economics. The old-fashioned view of development was “stage-based”: following upon the way England, and later US and Japan developed, it viewed countries as going through the import-substitution stage with significant tariff protection, then developing exports of simple manufactures and gradually moving into more sophisticated products. This was the idea that underlay most of development policy between the 1950s and 1980s. South Korea, Brazil and Turkey were the best examples. But in the 1990s, with the second globalization things changed. What became crucial for success was no longer to develop by own economic policy through various stages, but to become part of the global supply chains organized by the center (the “North”).

Baldwin’s argument changes the way we interpret Asia’s success in the current era: China, India, Indonesia, Thailand  are not repeating Korea’s experience, but are the trail-blazers of a new way to development that, by integrating one’s economy to the “North”, leapfrogs over several technological and institutional stages. To grow, it becomes crucial to be part of global supply chains. The most successful countries in the second globalization are those that due to institutional factors, skill and cost of their labor, and geographical proximity to the “North” are able to become an integral part of “Northern” economy. Baldwin’s  interpretation inverts (rightly, in my opinion) the old dependencia paradigm which held that “delinking” was the way to develop. On the contrary, getting “linked” is what made Asia traverse in a remarkably short  span of time the road from absolute poverty to middle income status.

What would be the third globalization? The ultimate (at least from today’s perspective) unbundling will come with the ability of labor to move seamlessly. This will happen when the costs of moving labor become low. For many operations that require physical presence of a person, the cost of temporarily moving that person to a different location is still high. But if the need for physical presence in a faraway location is solved  through remote control, as we already see in the cases of doctors performing operations remotely,  then labor may become globalized too. The third unbundling, that of labor (as an input in the production process) from its physical location, makes us think of migration and labor markets very differently: if tasks which now require physical presence of a worker can be done remotely by a person at any point on the globe, then migration of labor may be of much smaller importance. Through the third unbundling we can achieve a global labor market that may mimic the way the world would look with a fully free migration.

By placing today’s globalization in the context both of the previous globalization and of what may be the next one, Baldwin allows us to see the economic progress of the past two centuries as a continuum driven by the successive facilitations of movement of goods, information, and people. It also allows us to glimpse a utopia where everything can be quasi instantly and almost costlessly moved around the globe: the ultimate  victory over the constraints of place and location.   

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