Globalization and its impact on international trade

Abstract

This essay is based on the book: "The Next Global Stage: The challenges and opportunities in our borderless world", by Kenichi Ohmae. The theme chosen from this book is:" globalization and its impact on international trade". The essay discusses globalization and the extent to which the global economy has the potential not only to constrain but also to enable governments to pursue their policy objectives (Weis, 2009). This essay posits that if one wishes to account for impacts of globalization in any particular national setting, then one must start with the domestic institutions of governance, which mediate the challenges of openness

Keywords: globalization, the Next Global Stage, challenges and opportunities borderless world, challenges and opportunities

Introduction

 This essay is based on the book: "The Next Global Stage: The challenges and opportunities in our borderless world", by Kenichi Ohmae. Ohmae explains why economic theories of the past no longer work in today's global economy. He provides a blue print for today's business to succeed in this global economy. He reinvents the map by defining region states and the blue print for them to succeed as well. One major question he tries to address is about the global economy. What is globalization? What makes our economy a global one? Ohmae states that even though our borders are diminishing, most nation states still want to continue to have power on the movement of people and goods for security reasons. But in the business world, there are areas that have   proven   they   can   exist   without   many   constraints.   These   areas   are   in communication, capital corporations and consumers(Ohmae, 2005). In addition to being borderless, our economy has become more visible, cyber-connected and measured in multiples or expectation of success.

He argues that we must abandon our economic theories of yesterday. While they helped us to make sense of our economies in the past, and assisted us with devising appropriate legislature, the theories no longer work for the following reasons. The flow of money as described by Keynesian economics becomes complicated if two countries start   trading  a   multitude  of   different  products  and   services,  or   if   they  start communication with ultrafast computers.

The theme chosen from this book: "The Next Global Stage: The challenges and opportunities in our borderless world", is globalization and its impact on international trade. The essay discusses globalization and the extent to which the global economy has the potential not only to constrain but also to enable governments to pursue their policy objectives (Weiss, 2003). This essay posits that if one wishes to account for impacts of globalization in any particular national setting, then one must start with the domestic institutions of governance, which mediate the challenges of openness. This essay is organized under the following headings:

 1.  The meaning of Globalization

2.  Benefits of Trade

3.  Competition and Consumers

4.  Globalization and Domestic Institutions

5.  Countries and Condominiums

6.  Conclusion

The Concept of Globalization

The world economy is experiencing a fundamental change. We are moving away from a world in which national economies were relatively self – contained entities, isolated from each other by barriers by barriers to cross-border trade and investment, by distance, time zones and language, and by national differences in government regulation, culture, and business systems. And as Hill(2005) observes, we are moving toward a world in which barriers to cross-border trade and   investment are falling, perceived distance is reducing due to technological advances in transportation and telecommunication, material culture is beginning to look similar the world over, national economies are merging into interdependent global economic system. 

Globalization refers to the shift toward a more integrated and interdependent world economy. Globalization has several different features, including globalization of markets, and the globalization of production (Hill, 2005). The different definitions of globalization according to many authors, Annabelle and Betsy(2007), Boudreaux(2008), Schirm(2007) and   Cortell(2006),   converge around a common understanding of globalization as an integration of markets, a cross-border interconnectedness of economic spaces and thus a denationalization of economic process. Therefore, economic globalization shall be defined here as the increasing share of private cross- border activities in the total economic output of countries. With this basic definition, globalization can be measured as the share of foreign trade, foreign direct investment and financial transaction in the gross domestic product of a country or a region and as a share in the world product (Annabelle and Betsy, 2007; Boudreaux, 2008; Schirm, 2007 and Cortell, 2006).

The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global market. Falling barriers to cross border trade have made it easier to sell internationally. For some time, the argument has been that  the  taste  and  preferences of  consumers in  different  nations are beginning to converge on some global norm, thereby helping to create a global market(Bhagwati, 2004).

When we speak of globalization we typically talk of countries becoming more economically integrated with each other, of countries undertaking the actions that result in greater trade. For example, we speak of the United States buying more goods and services from China. So when a newspaper reporter writes that China is selling more goods to the United States, recognize that this statement really means that many individuals in that region of the globe that we call "China" are spending more of their time and resources making things for shipment to that part of the globe that we call "the United States" where many persons living there choose to buy these things.

This  insistence  that  individuals rather  than  countries  drive  commerce  might sound trite. It is not. Much misunderstanding sprouts from the failure to keep in mind that trade is done by persons not by countries or by governments. With this realization front and center, we correctly understand international trade as motivated by the same forces, and as unleashing the same consequences, as trade among citizens of the same country.

 Benefits of Trade

The question that comes to mind in the wake of globalization is: Why do any two persons trade with each other? The answer is as obvious as it appears to be, because each party to a trade expects to be made better off by that trade. If you choose to spend

$5.00 for a cup of coffee at Starbucks, you do so because, as you judge your own well- being, that cup of coffee will give you greater satisfaction than would whatever else you might buy with that $5.00. The owner of  the  Starbucks franchise also has similar reasons. Having an additional $5.00 in her still is worth more to her than keeping on hand the coffee she sells to you. Nothing about this explanation for voluntary trade implies that people do not make mistakes. Perhaps after taking a few sips of the coffee you realize that you ordered regular when you meant to order decaffeinated, or that you suddenly are no longer in the mood for coffee. You then regret for any purchase that is made.

But at the time you made the trade, clearly you thought that buying that cup of coffee was in your best interest. Otherwise you would not have bought it. When we look at the world with snapshot vision—say, looking at it only as it exists on a particular day such as August 24, 2012—about the only steps we can take to improve human well- being is to reallocate things that already exist. The example of you buying a cup of coffee from Starbucks involves such a reallocation. The coffee beans used to brew your coffee already existed when you decided to purchase your cup of coffee, as did the cardboard cup in which it was served to you, the machine that brewed the coffee, and the retail space that you entered to make your purchase. But even though nothing new was produced by your purchase, it is important to see that voluntary exchange generally makes all parties to the transaction better off. You are better off because ownership of that  cup of  coffee  was  reallocated from Starbucks to  you; Starbucks is  better  off because ownership of the $5.00 was reallocated from you to Starbucks. By simply reallocating goods from people who value them less to people who value them more, the well-being of society is increased.

And because each of us has incentives to seek out and strike deals that make us better off, and to avoid deals that do not, voluntary exchange, even of things that already exist, generally improves human well-being. But our well-being would not be improved very much if we did nothing but exchange things that already exist. Much greater and continuing improvement requires production. For standards of living to increase the economy must transform "inputs" into desirable "outputs."

A far more interesting question is what causes this wealth? Before we explore the answer to this question, it's interesting to notice that Smith did not ask "what causes poverty." Smith(1981) would have found such a question to be odd, if not downright meaningless. In Smith's time, even in relatively prosperous Western Europe, poverty was widespread. Poverty was the norm. Smith understood that poverty has no causes; it is, to use a modern term, humankind's default mode.  

If each of us does nothing, if each of us exerts no creativity and no effort, we will all be miserably poor. It is no challenge to "create" poverty. The real challenge, Smith realized, is to create wealth, especially enough wealth so that it is regularly available to ordinary people. Smith saw that wealth is rooted in specialization, what he called "the division of labor." If each of us must produce everything that we consume, with no help from others, we would be unimaginably poor. How does specialization cause such awesome increases in total output? Smith(1981) identified three reasons.

First, specialization reduces the time spent moving from job to job. Someone who tends crops in the morning and then cleans skyscraper windows in the afternoon must spend a good deal of time each day traveling from the farm to the city and back. This time spent moving from one job to the next is time not spent producing output. So if Sam specializes in producing nothing but wheat and Suzy specializes in doing nothing but cleaning windows, together they will produce more output than they would if each worked at both tasks.

 Second, specialization promotes the acquisition of skills; it promotes what Smith called "the increase of dexterity in every particular workman." If each day you spend only five minutes practicing the piano, you will never become a good piano player. This is true even if you are blessed with vast natural talent for that musical instrument. To become highly skilled, each week you must play the piano for many hours. And the more time you devote to playing the piano, the better you become at it. Put differently, the less time you must spend doing other things—growing your food, making your clothes, mowing the lawn, practicing karate—the more time you can spend honing your skills as a pianist and thus the better you become at making music with that instrument. What's true for piano playing is true for nearly every other endeavor. Persons who become skilled automobile mechanics achieve this distinction only by devoting a good portion of their time each week to repairing cars and trucks. Bakers spend much time baking. Neurosurgeons spend much time learning and practicing brain surgery. Practice and experience may not make someone perfect, but they are sure do improve that person's skills.

 Third, specialization increases the likelihood of machinery replacing human labor and, thereby, releasing that labor to produce outputs that could not before be produced. Suppose you visit a factory and see each worker performing all the tasks required to produce a pin. Each worker pulls some wire from a roll, cuts it, sharpens one end to a point and flattens the other end to make the pin's head. Each worker also packs the pins he or she makes into packing crates for shipment to market. If the factory owner asks you, "Hey, do you think you can make a machine to do what one of these workers does?" how will  you answer? You would have to be  an  exceptional genius of  an engineer to design and manufacture a single machine that does several very different tasks.   But now suppose that you visit another pin factory, one that has the same number of workers as the first factory.

In this second factory, however, one worker specializes in pulling the wire from the spool; a second worker specializes in cutting the wire; a third worker specializes in sharpening  one  end  of  each  piece  of  cut  wire  into  a  pin  point;  a  fourth  worker specializes in flattening the other ends of the pins into pinheads; and so on. If the owner of this second factory asks you to make a machine to do one of these tasks, you are more likely to agree that designing and manufacturing such a machine is doable. A machine that does nothing but, say, cut wire into pin-length strips is vastly easier to conceive and to build than is a machine that does this task plus many others.

So, Adam Smith reasoned, when a worker specializes in performing a distinct task, chances increase that this worker, or someone observing him, will perceive an opportunity for inventing a machine to do this specific task. With a machine now doing a task that previously required human labor, workers who once performed this task can now perform other  productive tasks.  Society gets  more  output  than before.  Smith concluded that the wealth of nations grows with the division of labor and with the trade that naturally follows from it.

 As each of us specializes in doing a small, distinct job—teaching economics, preparing income tax returns, performing dentistry, playing French horn for the New York Philharmonic orchestra—and then exchanging our output for that of millions of other specialists, we are all better off. Smith's explanation for the wealth-producing effects of specialization is important. But it was left to a younger British economist, Ricardo (2003), to discover and explain another, more fundamental reason why specialization  increases  the  wealth  of  nations.  That  reason  is  the  principle  of comparative advantage, and it is one of the most important discoveries in all of the social sciences.

The discussion so far reveals several different ways that specialization increases society's total  output of goods and services. Specialization saves workers' time, it enhances each worker's skill at  performing his or her job, it promotes the  use of machinery, and, perhaps most importantly, specialization done according to each worker's comparative advantage ensures that each productive task is performed by workers who can perform that task most efficiently. That is, at the lowest possible cost. Another interesting, and counter intuitive fact is revealed if we combine Smith's insight of how specialization increases the skill of each worker with Ricardo's insight about comparative advantage. Return to the above example in which Ann has a comparative advantage in fishing while Bob has a comparative advantage in gathering bananas. As we saw, under these circumstances, Ann will specialize more in fishing while Bob specializes more in banana gathering. But now suppose that one day while out fishing Ann is struck by a creative insight about how she can increase her daily catch. She might, for example, realize that using her sweater as fishing net will enable her to catch more fish daily than before. Now using more "capital goods" (her fishing net) than she used previously, Ann's capacity to catch fish rises. Let's assume that using the net increases her capacity to catch fish from 200 fish per month to 300 fish per month.

Ann's capacity to produce fish now is higher (by 100 fish per month), although her capacity to gather bananas is unchanged. And, of course, Ann's innovative use of her sweater as a fishing net does nothing to increase the quantities of bananas and of fish that Bob can produce in a month. In other words, while Ann certainly is better off having discovered an improved means of catching fish, Ann's discovery does not make Bob better off. In fact, Ann's greater capacity to catch fish makes even Bob at least potentially better off. To see how, note that before Ann began using a net, she was twice as efficient at fishing as Bob: each fish then cost Ann one-half a banana while each fish cost Bob one full banana. Now, not surprisingly, because her use of the net increases her efficiency at fishing, the cost to Ann of catching fish falls. Using her sweater as fishing net, each fish now costs Ann only one-third of a banana. She now gives up fewer bananas for each fish that she catches.

But here's the fascinating fact: by becoming a better fisherman, Ann necessarily becomes a worse banana gatherer. This is true even though her capacity to produce bananas remains unchanged. Before Ann learned to use the net, each banana she produced cost her two fish. Now, because using the net increases Ann's capacity to catch fish, each banana that she might now produce would cost her three fish. And although Bob's cost of gathering bananas has not changed, it remains one fish per banana; his cost of gathering bananas relative to Ann's cost has indeed fallen. Before Ann improved her capacity to catch fish, Bob's cost of producing bananas was half of Ann's cost of producing bananas (one fish per banana for Bob compared to two fish per banana for Ann). Now that Ann is a more productive fisherman, Bob's cost of producing bananas falls to one-third of what it costs Ann to produce bananas (one fish per banana for Bob compared to three fish per banana for Ann). In other words, when Ann improves her advantage over Bob at fishing, she simultaneously and unavoidably improves Bob's advantage over her at gathering bananas.

This comparative lowering of Bob's cost of producing bananas means that Bob enjoys at least the potential of increasing the number of fish that he can persuade Ann to give him for every banana that he sells to her. Before Ann began to use the net, the most that she would pay for each of Bob's bananas was two fish; now she is willing to pay up to three fish per banana.

 Competition and Consumers

 In the example above of comparative advantage, the gains from specialization and trade are shared pretty equally between Ann and Bob. This equality of sharing the gains  from  trade,  however,  need  not  be  true  in  reality  in  order  for  comparative advantage still to work for the improvement of all peoples' material well-being. If Ann is a more skilled bargainer than Bob, she might persuade Bob to accept fewer fish in exchange for his bananas. Being a better bargainer than Bob, Ann will enjoy more of the gains from specialization and trade than Bob will. But as long as both parties voluntarily trade with each other, each person nevertheless is made better off than he or she would be without specializing and trading. No matter how good a bargainer Ann might be, she will never persuade Bob to pay more than one banana for each of her fish. Bob will not pay, for example, 1.1 bananas for a fish from Ann given that he can produce each of his own fish at a cost to him of 1.0 bananas.

In reality, of course, there are millions of consumers and millions of producers, with each producer being highly specialized. No single person today, for example, specializes in making automobiles. Instead, automobiles are produced by thousands of people, each of whom specializes in one or two finely distinct tasks, such as designing body styles, building parts for internal-combustion engines, cutting sheet metal, welding, tanning leather for the seats, and so on. As workers specialize at ever more narrow tasks, the productivity from specialization increases, both for the reasons identified by Adam Smith and because of the principle of comparative advantage. Compared to our simple two-person, two-good example, the real world is marked by a division of labor that is wider (there are millions of goods and services, not only two, produced and consumed) and deeper (the production of each good or service for market typically requires many different specialists, each of whom contributes his or her talents to produce only a part of the final output).

 A widening and a deepening of the division of labor increases total output. Another consequence is that each person, while specializing at producing only one kind of output, deals as a consumer with countless numbers of suppliers. As a producer, your dentist performs a highly specialized task, but as a consumer he buys goods and services from many different suppliers—grocers, barbers, oil companies, furniture makers among others. The list is practically endless. Also unlike in the simple two- person model featuring Ann and Bob, the real world division of labor does not result in each producer having a monopoly over his particular task. Large numbers of people participating in  an  economy means not only that the  division of labor widens and deepens, it means also that several people will have a comparative advantage at any specific task.

The  result  is  competition  among  these  specialist  producers  for  consumers' dollars. With lots of fishermen, Ann will be obliged to sell her fish at prices no higher than those charged by other fishermen. With lots of banana sellers, Bob will be obliged to sell his bananas at prices no higher than those charged by other banana growers. So another advantage of international trade is that it increases the number of competitors in each industry which, in turn, helps to ensure that producers keep their prices competitive. We saw above that when Ann's capacity to catch fish increases, this improvement creates the potential to make Bob better off even though nothing about Bob's productive abilities changes. Competition makes this potential a reality. When Ann becomes a better fisherman, she captures more of the fish market by lowering her prices to levels that before would have been unprofitable.

If producers can collude to avoid this competition, they will do so. But collusion is practically possible only when the number of producers in an industry is very small and when the  likelihood of  new entry is minuscule. Shielding domestic producers from foreign rivals only increases the likelihood of successful collusion among firms in an industry.

Greater numbers of competitors mean also greater prospects for discovering and implementing improvements in production techniques, and a greater likelihood that such improvements will be mimicked or even bettered by other producers. The result of this competitive process is that, over time, production costs fall and prices are driven down to these new lower costs of supplying the good or service.