EUROPE CHAPTER 12: GLOBALIZATION AND ITS CHALLENGE TO

CHAPTER 12:

GLOBALIZATION AND ITS

CHALLENGE TO

EUROPE

WHAT IS GLOBALIZATION

• Globalization is market integration on a world scale

• I.e. domestic markets are increasingly dependent on international markets

– Prices reflect global rather than local demand and supply

• The product of

• Intensified trade: prices converge

• Capital mobility: interest rates converge

TWO PERIODS OF GLOBALIZATION

• First Era of Globalization: From mid-19^th century to the First World War

• Globalization backlash in the interwar period

• Second Globalization: From Second World War until today

• Markets as integrated in 1900 as they are today

– Except labour markets

• Extent of late 19^th century globalization not achieved again until 1970s or 1980s!

GLOBALIZATION AND THE LAW OF ONE PRICE

• Ultimate manifestation of globalization is a fully integrated market and the law of one price

• States that prices should be equal for an identical good traded in two different locations

• Only strictly true if transaction costs are zero

– Usually true for financial assets

• For commodities the law of one price implies that the

OBSTACLES TO THE LAW OF ONE PRICE

• Tariffs

• High costs of transport

• Unreliability and slowness of information transmission

– If you are not sure about the price at other locations it is too risky to trade

• Law of one price operated first within regions and nations, later in neighbouring nations

IMPLICATIONS OF THE LAW OF ONE PRICE

• As transport and transaction costs fall, there will be price convergence

• As information flows improve, any deviation from the law of one price will prompt faster price adjustments back to the law of one price

• Both the decline in transport costs and more efficient transmission of information are primarily 19^th century

THE ECONOMIC MECHANISMS BEHIND THE LAW OF ONE PRICE

• In short: trade and arbitrage

• If the price difference of a commodity between locations A (cheap) and B (expensive) exceeds the transport and transaction costs

•  profitable to ship from A to B to secure a profit

•  increased demand in A will increase price, decreased demand in B will decrease price

• Time for adjustment to take place depends on speed of information flows

THE LAW OF ONE PRICE FOR CAPITAL AND LABOUR MARKETS

• Capital: If cheaper to borrow in A than B

–  investors will borrow in A

–  interest rates increase in A and fall in B

• Labour: Convergence of wages not expected

– Restrictions on mobility

– Labour varies due to skills, human capital, access to physical capital, i.e. productivity

CONSEQUENCES OF GLOBALIZATION

• High inter-dependence of domestic and global price and interest rate movements

• Reduces price-setting market power of domestic industry

• Reduces power of trade unions to set nominal wages and costly improvements in working conditions

• Negative link between domestic labour cost and employment stronger than in a less open economy

GLOBALIZATION, DOMESTIC

PRODUCTION COSTS & EMPLOYMENT

WHAT DRIVES GLOBALIZATION?

• Politics and technology

• Policy: tariff policy, financial market de-regulation, immigration policy

– Political process of advances and retreats, due to winners and losers from globalization

• Technology: falling transport costs (steam), falling information costs (telegraph, commercial press)

REAL DOMESTIC AND TRANSATLANTIC

FREIGHT RATES

HISTORY OF CAPITAL MARKET INTEGRATION

• Currency markets on European level since medieval times

• Bills of exchange became instrument of credit

• Efficient arbitrage via postal services between major financial centres of London and Amsterdam in 17^th and 18^th centuries

– But probably not elsewhere

• Telegraph in 1860s and 1870s brought instantaneous information flows

ADVANTAGES AND DISADVANTAGES OF INTERNATIONAL CAPITAL FLOWS

• Advantage: Domestic investments not constrained by domestic savings

– Relieves economies of potentially harmful effect of insufficient savings on growth

• Disadvantage: Large current account deficits or

surpluses can persist, governments can end up defaulting on international debt

WERE CAPITAL MARKETS EFFICIENT?

NOM. INTEREST RATE DIFFERENTIALS

THE DIRECTION AND MAGNITUDE OF CAPITAL FLOWS

• 19^th century: UK dominated, with France and Germany

• In the 20^th century the US emerged as the major foreign investor

• Foreign investments insignificant during the Industrial Revolution

• By 1850 stock of capital was 50% of world GDP, fell during 1930s and Bretton Woods

DISTRIBUTION OF CAPITAL RECIPIENTS

• In first globalization the developing world received about one third of foreign investments

– Raw material extraction, infrastructure investment

• By end of 20^th century developing world received just 10%

– Multinational firms invest in middle to high-income nations with a market for their goods

COMMODITY MARKET INTEGRATION

• High transport costs and tariffs means we should not expect price gap to fall to zero

• Speed of adjustment is also important

• Earlier short distance market integration, but long distance integration only from 19^th century

• Divergence in prices in 20^th century as tariffs rose

– Still the case for agricultural goods

WHEAT PRICE CONVERGENCE

BETWEEN THE UK AND US

INTEGRATION OF LABOUR MARKETS

• Convergence from migration of labour from nations with excess labour and low wages to nations with excess

demand and high wages

–  Wage differential predicts migration flows

• But ‘home culture bias’ and prohibitive transport costs before 1850, mostly forced migration, e.g. slaves

• Mass migration after 1850: Europe to New World

DOES TRADE CAUSE WAGE DIVERGENCE?

• Divergence after 1850 due to increased growth in Europe and not because growth in rest of the world fell

• Trade pattern in 19^th century erased Indian dominance in textiles at home and abroad

•  ‘De-industrialization’ and deprivation of dynamic gains from modernization?

– No, because trade was a small share of the Indian economy, and agriculture does not mean slow productivity growth

– Real problem was low education, poor institutions

GLOBALIZATION BACKLASH: TRADE OPENNESS AND MIGRATION

• Mass migration ended in early 20^th century

• US went from protectionism and free migration to free trade and constrained migration

– Paradox, since trade and migration have same effect on wages

• Europe has also restricted immigration

• Does globalization lead to worsening of working conditions?

OPENNESS AND LABOUR STANDARDS

IN 1913

GLOBALIZATION BACKLASH:

PROTECTION SINCE 1950

• Belief that modernization cannot be based on food and raw material exports

• Developing nations started import substitution industrialization (infant industry protection)

– Tariff protection, subsidies to industries

• Results were mixed, disappointing in Latin America, good in Asian economies

GLOBALIZATION BACKLASH: THE TALE OF THE TWIN FARM PROTESTS

• Real grain prices in the US increased during the ‘grain invasion’ of Europe in the late 19^th century

• Paradox? US farmers protested!

• Previously believed that farmers suffered from nominal illusions during deflationary period

• New research suggests that falling domestic freight rates meant that farmers located further west for export to East Coast and Europe where they suffered more from

monopoly prices of rail firms

FREIGHT RATE REDUCTIONS AND THE

PRICE RECEIVED BY US FARMERS

SUMMARY

• Two globalizations: late 19^th and 20^th centuries

• Present globalization incomplete, migration restricted, agriculture protected

• Global economy opens opportunities but gives

challenges  possibility of globalization backlash

• Increased market size, good government and openness to trade, factor flows and ideas lead to growth

– Globalization is the ultimate, but not irreversible, stage in this process

SUGGESTIONS FOR FURTHER READING

SUGGESTIONS FOR FURTHER READING

SUGGESTIONS FOR FURTHER READING