Perils of a New Globalization

By Stephen Roach

Economics and politics are on a dangerous collision course. As the forces of globalization strengthen, the drumbeat of protectionism is growing louder. Made in France, the European strain of protectionism reflects a newfound nationalism that strikes at the heart of pan-regional integration. Made in America and exacerbated by fear of the “China factor,” a different strain of protectionism plays to the angst of middle-class U.S. wage earners.

Whether the threat is perceived to be from the inside (Europe) or the outside (the United States), the responses of increasingly populist politicians are worrisome, to say the least.French Prime Minister Dominique de Villepin is seeking to protect “strategic” industries from foreign ownership. In the U.S., it’s not just resistance to foreign takeovers, with bipartisan support building in the Senate to impose steep tariffs on China. All this harkens back to the demise of an earlier globalization that many date by the enactment of the infamous Smoot-Hawley Tariff Act of 1930 – a political blunder that may well have been key in turning a U.S. stock market crash and recession into worldwide depression.Like the circumstances over 75 years ago, the current global trade dynamic has played an increasingly important role in boosting the world economy. Protectionism and the contraction in global trade it would trigger puts all that at risk.

Today’s world, of course, is very different than it was back then. So, too, are the forces of globalization that are causing such a powerful political backlash. In the early part of the 20th century, the world was brought together by the cross-border exchange of manufactured products. In the early part of the 21st century, globalization has swept into a very different realm of commerce – information flows, financial capital, and services.

A globalization that moves from the tangible aspects of tradable goods activity to the more intangible functions of the Knowledge Economy is not well understood. But the impacts of this shifting character of cross-border integration could well be more powerful today than they were in the past. Blue-collar workers in factories have long been on the front line in facing global pressures. White-collar workers in service-based enterprises have not. That was then. The rules of engagement on the battleground of globalization have changed. Like manufacturing, the services economy is now on the leading edge of feeling the stresses and strains of an increasingly competitive and open world economy.

This is an extraordinary development in the continuum of economic history. Economists have long dubbed services as “nontradables” – underscoring the time-honored proposition that service providers had to be in close proximity with their customers to offer in-person delivery of expertise, advice, or assistance. In the Internet Age, that contract has been re-written. Now, with the click of a mouse, many once nontradable services can be offered from anywhere in the world. At work is the globalization of software programming, engineering, design, medicine, accounting, consulting, and a multitude of other professional services. The result is an IT-enabled globalization that throws long-sheltered knowledge workers into the global competitive arena for the first time ever.

As was the case in the early 1930s, the globalization of labor markets is at the heart of today’s protectionist backlash. But the pressures are very different as they migrate from manufacturing to services. That’s not to say blue-collar workers aren’t feeling the heat in today’s world. Unfortunately, there just aren’t that many of them left. Factory sector workers currently account for only about 15% of total employment in the G-7 collection of major industrial countries (the U.S., Canada, Japan, France, Italy, Germany and the U.K.) – about half the 29% share prevailing as recently as 1970. While there could well be more to come in the attrition of manufacturing employment – the U.S. portion is now close to 10% – simple math tells us this aspect of the hollowing has just about run its course.

With the pendulum of global competition now swinging toward services, the resulting white-collar shock has added a new and very destabilizing element to the globalization debate. It has created a deepening sense of anxiety that afflicts workers who have long harbored the belief that they would not have to face pressures from low-wage offshore talent pools. The persistent stagnation of inflation-adjusted wages in the developed world – even in a high-productivity-growth U.S. economy – has shattered that sense of security. A powerful global labor arbitrage is at work – triggering a wrenching compression of real wages in the rich, developed world, while, at the same, allowing pay rates to rise in the low-wage developing world.

Politicians have been quick to come to the defense of the new warriors of globalization.The numbers leave them with little choice. Unlike the sharply reduced ranks of manufacturing-based employment in the developed world, services are the dominant source of work, income generation, and political power. In the G-7 countries, services currently account for close to 75% of the total workforce – literally five times the share of manufacturing. And yet that’s where the current strain of globalization is playing out with greatest intensity – and where it meets its greatest resistance from the politicians. Little wonder that services reforms have stalled in Europe, or that the Doha Round of global trade liberalization has been stymied by a highly contentious debate over services.

Significantly, the new globalization could be far more disruptive than the strain of the early 20th century. That’s due importantly to the extraordinary speed of the transformation now at work. Courtesy of rapidly increasing e-based connectivity, together with ever-widening low-cost bandwidth, the global labor arbitrage is moving rapidly up the value chain. Five years ago, when the debate was first joined on white-collar offshoring, the focus was on relatively low-value-added data processing and call centers. Today, the whole gamut of higher-value-added professional services workers is feeling the heat. Unlike the relatively slow-moving globalization in tradable goods, IT-enabled globalization has moved at hyper-speed to the upper echelons of the occupational hierarchy in the white-collar services economy.

The debate breaks down over what needs to be done. The rich countries have opted for protectionism while the poor countries continue to bet on export-led growth. Meanwhile, a confluence of powerful new competitive forces – the open architecture of IT-enabled connectivity, the push for efficiency solutions in the high-cost developed world, and the availability of an enormous reservoir of high-quality offshore knowledge workers – drives the new strain of globalization ahead at breakneck speed. At the same time, the global labor arbitrage is forcing a realignment of relative wages in the world economy – with the developed world fearing a “race to the bottom” while the developing world is hoping to ride the rising tide. The combination of IT-enabled services globalization and real wage stagnation in the rich developed world is too tempting for populist politicians to resist.

Unfortunately, there is no easy resolution of these political and economic tensions. In the end, the competitive profile of any knowledge worker reflects the interplay between skillsets and fully-loaded costs. A nation’s stock of human capital is key in shaping the former, while the ever-declining price of IT-enabled connectivity puts an important new wrinkle into the cost calculus. Countries that sign up for globalization must meet both aspects of this challenge head-on. The hyper-speed by which this challenge is changing in the Internet Age adds a critical urgency to the politicization of globalization – and to the protectionist pressures it has evoked.

The orthodox prescription is to counsel patience – that the “win-win” of globalization eventually will raise living standards in the developing world while creating new markets to be tapped by industrial countries. Yet, the hyper-speed of an IT-enabled globalization draws the rewards of that patience into serious question – at least for the foreseeable future. In the end, politicians are always best at counting votes. With workers in services outnumbering those in manufacturing by a factor of five to one, the body politic in the industrial world has cast its ballot in favor of protectionism. Opportunistic politicians are taking the bait – seemingly unconcerned about the tragic lessons of the 1930s. While today’s globalization is very different than it was back then, the risks of making a big mistake on trade policy should not be minimized.