A Silver Lining (Part 4)

Would it be wishful thinking to hope that that there is a silver lining to the Covid-19 cloud hanging over the world? Every event that brings about change also brings about opportunities.

Globalisation was inherent in Adam Smith’s ‘Wealth of Nations’ in which he made a strong case for ‘Duty Free’ trade. This was made much clearer by Ricardo who emphasised that protection of an industry against foreign competition, where the foreign competitor had a natural advantage, was counter productive, and amounted to penalising the local population.

It became the watchword of the 1980’s and has ever since been the primary economic thrust in the world. There was little real thought given, by politicians or economists, to the consequences of globalisation. It seemed a natural that expanded markets would allow for expanded production and therefore growth.

As soon as one stops and tries to think through the process, one will come to the conclusion, that depending on the availability of suitable labour, raw materials, the level of regulation and political stability the business must move it’s manufacturing production to the country with the lowest cost equation. (Cost Equation = Wages + Interest + Rent + Profit and Tax). Initially this might be low tech industries with a high element of labour cost, but dependent on skills and education levels will slowly encompass all forms of manufacture where the cost differential is greater than the cost of transport back to the home market. The pressures created by this process will only end when the cost equations have been equalised across the world.

Initially the opening up of the markets in the East to the goods manufactured in the West resulted in expanded markets. Allowing for the scaling up of production reducing average cost, and, because the home markets were not price sensitive, businesses were able to sell into those new markets at a lower price, while still increasing overall profit. An apparent win win situation. However, with the low income levels in the target markets, penetration was limited, and the only way to fully exploit those markets was by setting up manufacturing operations in those markets.

The UK with a long history of global trading with much of Adam Smith and Ricardo at the heart of our economic beliefs saw the start of a new wave of globalisation during the 1980’s. Unlike earlier export led trade, to largely captive markets of Empire and Commonwealth, this involved the moving of the ‘smoke stack’ industries to the East where the combination of looser regulation and lower cost equation resulted in a reduction in cost, while substantially improving air quality in the UK.

In the UK we have passed the phase of relocation of primary manufacture and have started seeing the relocation of more sophisticated manufacture (for example Dyson) to the East. This movement, while still in it’s infancy, will gather pace creating a problem for the economy, of how to replace the relatively skilled jobs lost to foreign countries.

This process has reached further down the line in the USA. Which has resulted in a strong rise in Nationalism and Trump’s attempts at creation a more protectionist economy by resorting to import tariffs. From Adam Smith and Ricardo we know that this is counter productive as it only amounts to penalising the local population by increasing the price of goods. Adam Smith said that while we might be able to create a monopoly within our country, we could never create a world monopoly and that monopolies were bad as they promoted inefficiency and the misuse of resources.

The drive to manufacture at the lowest possible cost, has also resulted in very complex ‘just in time’ supply chains, which, as Covid-19 has shown us, are vulnerable to shock. In the case of Sweden who did not enter ‘lock-down’, they found that the Volvo Plant had to shut down because of the failure of the ‘supply chain’. Sweden Central Bank is predicting as big a hit to it’s economy as Germany in spite of no lock-down.

So, while globalisation, in theory, brings  the benefit of  delivering goods at the lowest possible cost, it is by no means a panacea. Growth does not happen because of trade deals, it happens because of business investment and rising real wages. When we look at the USA we actually see an economy where there has been active disinvestment by business, resulting in the decline of factory output, this decline was initially offset by a fall in inflation as locally manufactured goods were being replaced with imports from countries with a lower cost equation, mainly China but also the rest of South East Asia. This has led to a Trump government, with a very Mercantilist attitude aiming at protectionist policies.

In the UK we have also seen inflation suppressed by cheaper imports resulting in the demise of many industries (clothing and Footwear as examples,) and while we have seen some disinvestment, the main problems, in our economy, stem from a lack of investment by business. Growth in our economy, during the last decade, has come through expansion of consumer credit, rather than increased wages. This is actually unsustainable, but we need to tread carefully with our ‘global’ ambitions to avoid falling into the same trap that the USA has fallen foul of.

The long term results of Globalisation are good, in that they imply and equalisation of the cost equations of countries around the world, the difficulty is what happens between A and B. Possibly as the saying goes, ‘there is no gain without pain’. Our politicians should be honest with us and tell us exactly where they are leading, instead of simply feeding us sound bites.

Perhaps Covid-19 can lead to honest politics once the dust settles. I will deal with International trade in the next section.

 

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