Chapter 5 The Political Economy of Global Production and Exchange



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Chapter 5

The Political Economy of Global Production and Exchange

Thomas D. Lairson,
in Lairson and Skidmore,
International Political Economy: The Struggle and Wealth in a Globalizing World

Introduction
I. Patterns of Global Trade
The Triad of Global Production

Global Imbalances
II. Explaining the Expansion of Global Trade
The Political Economy of Free Trade

International Institutions and Global Trade

Negotiations Under GATT and Creation of the WTO

The Domestic Political Economy of Trade
III. The Impact of Transnational Firms

Global Trade and Transnational Firms

Foreign Direct Investment and Global Production

Transnational Firms and the Global Economy

Global/Regional Production Networks
IV: Regions of Production, Trade and Investment

Regions of Production and Trade: The European Union

The Rise of Preferential Trade Agreements
V. Conclusions: Evaluating the Gains and Losses from Trade
The rapid expansion of global trade over the past several decades will be examined through the prism of the interactions among governments, international institutions, multinational corporations, global banks and global markets. The globalization of trade can be traced primarily to the creation of global political institutions and to the effects of technological change on the behavior of multinational firms. A central topic is the GATT/WTO process of negotiated reductions in barriers to trade and creation of a set of enforceable trade rules, including the recent regionalization of trade agreements. The most important regional agreement remains the European Union and the enormous effects this has had on trade. Other important topics include the relationships of multinational firms and states seeking foreign direct investment from these firms, the processes of offshoring and outsourcing, and the changing forms of trade. The nature of global production networks as a new set of capabilities of firms and states is discussed. Global production networks are related to the geographic restructuring of global trade, in terms of global balances and the geography of specialization. The interaction between global firms seeking production sites and nations able to create local complementary resources to support production is the key to understanding what is produced and where.
Understanding the global distribution of trade permits assessment of the distribution of gains, particularly in light of the assumed gains from free trade. The effects of freer trade on the interests of nations and groups through the restructuring of global resources and opportunities offers one measure. We consider the gains and losses from U.S.-China trade and the impact of global production networks on the global distribution of gains and losses. Finally, we examine how national politics and policy-making change in the context of relatively free global markets in trade and finance. This includes understanding which domestic interests gain or lose from globalization and the types of domestic institutional adaptation that occurs in response to the growth of international interdependence.


Introduction

Over the past two centuries, the geography of global production and exchange has experienced two large swings, resulting in radical changes in the relative prosperity of nations and regions. In 1820, the dominant economic power in the world – measured by the size of economies - was China. What followed was an industrial revolution concentrated in the West and largely missing from most of the rest of the world, especially China. For more than a century after 1820, the rapid globalization of trade and financial flows accompanied industrialization. Changes in the technology of production interacted with changes in the technology of communication and transportation to give those nations developing and adopting new capabilities enormous economic and even military advantages over those that did not. In 1820, China’s GDP was about one-third of global GDP and that of the British and United States combined was about 7%; by 1950, this same figure for China was near 4% and for the UK plus US was about 34%.1


The second great swing in the global geography of production began in the 1970s and continues to the present. In 1973, China’s proportion of global GDP remained low at 5% and the US+UK remained high at more than 25%. A second great wave of industrial transformation and globalization, again driven by technological change, was underway and also continues to today. The effect was to radically shift the locus of global production and trade, and the result was to transform many previously poor nations into global economic powers. By 2003, China had quadrupled its global GDP share to 16% and the U.S.+UK had dipped slightly to 24%. By about 2020, the Chinese economy is expected to equal and then surpass the U.S. economy in size and by 2030 exceed the U.S. by as much as 30%.2
Expanding our view to include all emerging economies gives an even more striking sense of the significant changes in the global structure of production in the last three decades. These relatively poor nations are labeled as emerging because they have moved toward rapid economic growth, even as the growth rates in rich nations were somewhat stagnating. Emerging economies typically had recent growth rates of three or four times that of rich nations, and this compounding over time led to rapid catch-up. Some comparisons make this clear. In 1990, rich nations held 80% of global GDP and poor nations (emerging economies) only 20%. Just two decades later, in 2011, this ratio had shifted to 60%-40%. Projecting into the near future, by 2018 the ratio will be 50%-50%, a stunning shift in global economic relations in in less than 30 years.3
During the recent period when the global geography of production has changed so much, one of the main drivers has been the rapid expansion of global trade. Much of the growth of many emerging economies can be traced to the ability to export more and more products to wealthy nations. One of the core features of globalization is this process and its connection to the creation of global and regional production networks.
This chapter examines in detail the nature, sources and consequences of the globalization of production and exchange. We will review much of the data on global trade, which provides a clearer picture of what is produced, where it is produced and the patterns of exchange and global imbalance. Equally important are the global actors that facilitated and pressed this process forward. These include dominant economies like the U.S. and Europe, but also include smaller emerging economies such as Korea, Taiwan, Saudi Arabia and larger nations such as China. Trade growth comes from the ability of nations to change the rules for trade and even create institutions to manage and adjudicate these rules. The General Agreement on Tariffs and Trade (GATT) and its transformation into the World Trade Organization (WTO) are essential sources in the expansion of trade. Regional trade arrangements, especially the European Union, have propelled trade increases and transformed the locus of production. The immediate agents of global trade have become multinational corporations. These firms invest across the world in facilities for production, organize and integrate globally distributed supply chains, and then market these products on a global scale.
The interactions among states, firms and global institutions created the new patterns of global markets and led to the existing and projected shifts of production and prosperity. The expansion of global trade has substantial and differential effects for nations and for various groups within nations. And the creation of such a system of relatively free trade can only happen when the political processes and economic policies of nations are willing to support and sustain it. Put simply, but accurately, the winners from global trade must somehow prevail politically over the losers from global trade. Understanding the patterns of winners and losers and the political processes associated with expanding global trade is a key feature of this chapter.


I. Patterns of Global Trade
We begin with some basic information about the patterns of global trade. This includes the role of trade in globalization, where trade takes place, the regions and nations that dominate global trade, the openness of nations to trade (Goods + Services Trade/GDP) and the imbalances in global trade.
Throughout the post World War II era, the connection between global merchandise and services trade and global prosperity has been a close one. And for almost every year, growth in trade has been higher than growth in GDP, a clear indication of the expanding globalization of trade in relation to domestic economic activity. Between 2001 and 2011, global trade as a proportion of global GDP rose from 23.8% to 29.7%.4 However, severe economic downturns such as in 2008-2010 do result in a larger decline for trade than for overall economic activity, a sort of de-globalization. So, in 2009 trade fell by 12% as economies declined on average by 2.5%. An important feature of this decline is the centering in developed nations, especially the United States. The result has been a somewhat differential pattern of decline and recovery, with developed nations having a sharper decline and a slower recovery than developing nations. This has also been true for trade.5
The Triad of Global Production
There are three great poles of global trade: Europe, Asia, and North America.
TABLE V.1

Global Trade (Merchandise and Services) by Region, 2008 (billion $US)
Total (M+S) Merchandise Services

Global Trade 19,943 16,117 (80.8%) 3,826 (19.2%)
North America (% total) 2,638 (13.2%) 2,035 (12.6%) 603 (15.8%)
US 1,805 1,287 518

Canada 522 456 66

Mexico 290 272 18
Europe 8,440 (42.3%) 6,469 (40.1%) 1,971(51.5%)
Belgium 557 472 85

France 782 616 166

Germany 1,702 1,446 256

Italy 661 543 118

Netherlands 740 638 102

United Kingdom 745 460 285


Asia 5,601(28.1%) 4,726 (29.3%) 875 (22.9%)
China 1577 1,431 146

Hong Kong China 462 370 92

Japan 929 782 147

Korea 498 422 76

Singapore 435 338 97

Source: WTO, International Trade Statistics, 2010, 181-184, 189-191.


Not only is global trade dominated by three areas, but the trade of these areas is regionally defined, as a nation’s trade partners are predominately those in its geographic region. This is true for the greatest poles of trade in Europe, Asia and North America but far less true for nations that account for a much smaller proportion of global trade, as seen in TableV.2.
TABLE V.2

Regional Merchandise Trade Flows
Region % Total Trade with Regional Partners
North America 37.9

Europe 70.9

Asia 57.8
South and Central America 27.4

CIS 27.9


Africa 11.5

Middle East 20.9

Source: WTO, International Trade Statistics, 2010, 10.

A small number of nations dominate global exchange. The top 15 nations in global merchandise trade account for 63% of all such trade.


TABLE V.3

Top 15 Nations in Global Trade, 2009 (Billions $ US)
Merchandise + Services Trade

Nation Exports (M+S) Imports (M+S) Exports (M+S)/GDP

United States 1530 1936 11%

Germany 1353 1191 41

China 1331 1164 27

Japan 707 699 13

France 627 686 23

Netherlands 589 530 69

United Kingdom 585 643 28

Italy 507 528 24

Belgium 449 426 73

Korea 421 398 50

Hong Kong 415 396 195

Canada 374 408 29

Singapore 357 327 200

Russian Federation 344 251 28

Mexico 245 263 28

Source: WTO, International Trade Statistics, 2010, 180-194. World Bank Data, http://data.worldbank.org/indicator/NE.EXP.GNFS.ZS

Components of Global Trade

Merchandise Trade

One general division of merchandise trade is among manufactured goods, agricultural products and fuels and mining. Manufactures cover a vast range, such as steel and iron, automotive products, high technology such as telecom equipment, computers and communication devices and integrated circuits, chemicals and pharmaceuticals, and clothing and textiles. Agricultural products are similarly diverse, with food and various derivative products such as palm oil. Fuels and mining include oil and a large variety of minerals such as copper, magnesium, and rare earth minerals.



Commercial Services

A second major category of global trade consists of commercial services. This typically includes non-tangible but valuable products that both support merchandise trade and provide value for transactions. Such items as transportation, communication and telecommunications, insurance, financial, and computer services are significant categories in international trade.



Distribution of Global Trade, 2010

Total Global Trade 100%

Merchandise Trade 80.6

Commercial Services 19.4

Source: WTO, World Trade Report, 2011, 24.
FIGURE V.1

TABLE V.4

Distribution of Global Merchandise Trade, by region (% global trade)
(Figures show the % of manufacturing, agricultural, and mine/fuel for each area)
Region Manufacture Agriculture Mine/Fuel

EX IM EX IM EX IM
World 68.6 68.6 9.6 9.6 18.6 18.6
North Am. 70.5 73.0 11.2 7.0 13.6 17.5

South/Cent. Am 27.4 68.8 30.5 10.0 38.9 18.3

Europe 77.3 70.9 10.5 10.7 9.6 15.6

CIS 24.1 72.6 8.7 14.0 62.9 12.0

Africa 19.2 69.5 10.2 14.3 64.0 13.5

Middle East 27.3 77.0 2.6 11.2 68.0 9.0

Asia 79.7 62.8 6.3 8.6 10.8 26.0

Source: WTO, International Trade Statistics, 2010, 45-46.


This table reveals important information about the composition of global trade. First, is the overall dominance of manufactured goods in global merchandise trade, although this statement masks the considerable variation in the role of these goods in the exports of many nations, related to some level of regional specialization. Though manufactures compose over 77% of Europe’s exports, these total only 19% of Africa’s, 24% of the CIS and 27% of Middle East and South and Central America’s exports. Second, agriculture represents almost a third of the exports of South and Central America but only 2% of the Middle East. Manufactured goods are an even more important part of the exports of Asian nations. For most of the last two centuries of global trade, the dominant pattern was for poorer nations to export agricultural goods and raw materials to richer nations, which in turn exported manufactured goods to each other and to poorer nations. Only in the last 40-50 years have less developed nations become major exporters of manufactured products.
Global Imbalances
Because trade takes place among nations with different currencies, the relation of inflows and outflows of goods and money matters. Under most circumstances, a nation obtains the ability to purchase imports by selling its products abroad and gaining foreign exchange. Of course, nations also gain foreign exchange from inflows of investment and loans from abroad and this can serve to offset a balance of trade deficit. On a global level, large and persistent imbalances in trade can call forth adjustments in financial flows, in the form of loans and investment. But such imbalances are difficult to sustain through time, because other nations’ investors and lenders are not likely to continue such behavior indefinitely. Long-term imbalances in trade can also reveal important imbalances in competitive advantage among nations.
The global trading system after 1945 was in many ways a creation of the United States and its preferences, policies and power. An essential feature of this power – the role of the U.S. dollar as key currency – creates the major exception to the patterns just described. Unlike most nations, the dollar as key currency meant the U.S. could purchase goods from abroad with dollars and need not exchange its currency for another. Indeed, the dollar has effectively functioned as a global currency for many transactions. Most nations were eager to hold dollars as the largest part of their foreign exchange reserves for this reason. This has permitted the U.S. to operate with a persistent current account deficit for decades, with a variety of nations holding and using the dollars they accumulated.6
The economic crisis of the 1970s led to larger and larger global imbalances over time, largely driven by U.S. policies.7 Flexible exchange rates and rising oil prices led to large trade deficits and slow economic growth often yielded larger budget deficits in many advanced nations. Market-based and policy-based decisions relating to shifting away from manufacturing and toward services and finance created large opportunities for the growth of manufacturing in several Asian nations. Rising government spending and lower taxes led to ever increasing budget deficits. The result was a secular trend toward increasing trade deficits and budget deficits, especially by the United States.
The key measurement of global imbalances is current account deficits and surpluses, especially when these are concentrated between certain nations or regions (see Chapter 2 for details). For more than a decade beginning in 1980, adding together current account surpluses and deficits totaled an average of 2% of global GDP. In the mid-1990s and until the global financial crisis of 2008, this measure rose almost continuously to average 6% of global GDP. These imbalances were very much concentrated in surpluses by Germany, Japan, oil exporters and China and in deficits by the United States.8 The U.S. current account deficit peaked in 2006 at more than $800 billion or 1.3% of global GDP. Of this, more than one-half was with Asia as a whole and one-third with China alone. 9 Because of the dollar’s role as key currency and because nations such as China, Japan and Korea wanted to preserve the trade surplus with the U.S., the dollars used to purchase these goods were held by these nations and used to buy U.S. debt. The system of financing trade and budget deficits suffered a major setback with the global financial crisis but persists at a much lower rate in subsequent years. We can see the persistence of global imbalances from 1980-2010 in Figure V.2.

FIGURE V.2


II. Explaining the Expansion of Global Trade
The Political Economy of Free Trade
However much free trade can be shown to produce mutual gains for nations, achieving free trade always involves a deep web of political relationships operating within nations and between them as well. This is because free trade is a political choice about the rules for economic interaction with the rest of the world.10 Moreover, the gains from trade are not evenly distributed and almost always involve relative and even absolute losses for some groups and for the interests of some governments. The economist’s retort that reallocating resources produces efficiencies for all is generally correct but masks the reality of lost jobs, lost profits, the burdens of retraining and the strategic importance of some products and goods. A policy of free trade in a democratic society requires mechanisms for choosing rules that will invariably help some and hurt others. In non-democratic societies, free trade is more closely linked to the strategic calculations of political leaders but gains and losses still exist. Further, we should consider the possibility that political leaders, even in a democracy, may see the potential from free trade and engage in the political mobilization of groups that could benefit from this policy.
Creating a system of free trade also requires that nations cooperate to develop and define the specific rules about how trade relations will work. Even with a specific set of rules and standards, some nations may be tempted to defect from a general preference for free trade. This possibility can be reduced through some sort of international institution, which functions to enforce these rules. Further, even when support for free trade is widespread across nations this will be uneven, especially across different industries, and this will affect the precise wording of the rules that might be adopted. The actual process of cooperation will require considerable negotiation and bargaining among nations. More generally, we can say that free trade requires a system of political relations within and among nations that will support and sustain free trade, by emphasizing the gains and minimizing the losses, combined with global institutions to interpret and enforce the rules.11
So it is for the system of free trade that developed in the decades after 1945 and which was a result of the power and preferences of the United States and its ability to construct a global free trade regime. During the period until about 1965, achieving freer trade was a project promoted domestically and internationally by the United States, primarily with its major allies in the Cold War, namely Europe and Japan. And freer trade quickly merged with and sometimes competed with the goal of rebuilding the economies of these nations as bulwarks in the struggle against the Soviet Union. This led U.S. officials to tolerate asymmetrical free trade rules, with Europe and Japan engaging in significant polices of protection and the U.S. maintaining a relatively open market for the exports of these nations. Negotiated agreements within GATT usually permitted much higher tariff barriers for U.S. allies than for the U.S. and typically excluded products with high levels of political sensitivity.12 The ability of the U.S. to negotiate freer trade depended on a domestic political relationship that involved a commitment to protect the incomes and economic position of groups adversely affected by international trade. This arrangement of “embedded liberalism,” whereby liberalization of trade was sustained by efforts to maintain economic growth and welfare policies, received widespread support across the political spectrum.13 This system began to break down, at least with respect to working classes, in the 1970s.14
Thus, international cooperation for freer trade rested on a political base of U.S. global power and international and domestic political commitments, combined with bargains that decidedly benefitted U.S. allies. The negative effects on some U.S. producers were ignored and this was managed politically through appeals to the demands of the Cold War conflict. The various agreements on trade under GATT were successful in lowering tariffs but also excluded significant areas of trade and rules affecting trade. The real goal was freer trade, not free trade. And yet, tariff levels did fall and trade rose by 7% per year on average from 1948-1990.15 Perhaps the most important political basis for freer global trade was domestic economic growth in the United States and abroad, which ameliorated the negative effects of trade liberalization on uncompetitive sectors and generated widespread gains to smooth the transition.16 Over time, this growth in trade served to mobilize and engage the interests of the beneficiaries of trade in the U.S. and abroad.
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