Chapter Outline

Drivers of Globalization

Two macro factors seem to underlie the trend toward greater globalization. The first is the decline in barriers to the free flow of goods, services, and capital that has occurred since the end of World War II. The second factor is technological change, particularly the dramatic developments in recent years in communications, information processing, and transportation technologies.

Declining Trade and Investment Barriers

During the 1920s and 30s, many of the nation-states of the world erected formidable barriers to international trade and foreign direct investment. International trade occurs when a firm exports goods or services to consumers in another country. Foreign direct investment occurs when a firm invests resources in business activities outside its home country. Many of the barriers to international trade took the form of high tariffs on imports of manufactured goods. The typical aim of such tariffs was to protect domestic industries from "foreign competition." One consequence, however, was "beggar thy neighbor" retaliatory trade policies with countries progressively raising trade barriers against each other. Ultimately, this depressed world demand and contributed to the Great Depression of the 1930s.

Having learned from this experience, after World War II, the advanced industrial nations of the West--under US leadership--committed themselves to removing barriers to the free flow of goods, services, and capital between nations.8 This goal was enshrined in the treaty known as the General Agreement on Tariffs and Trade (GATT). Under the umbrella of GATT, there have been eight rounds of negotiations among member states--which now number over 130--designed to lower barriers to the free flow of goods and services. The most recent round of negotiations, known as the Uruguay Round, was completed in December 1993. The Uruguay Round further reduced trade barriers; extended GATT to cover services as well as manufactured goods; provided enhanced protection for patents, trademarks, and copyrights; and established the World Trade Organization (WTO) to police the international trading system.9 Table 1.1 summarizes the impact of GATT agreements on average tariff rates for manufactured goods. As can be seen, average tariff rates have fallen significantly since 1950 and under the Uruguay agreement should hit 3.9 percent in 2000.

In addition to reducing trade barriers, many countries have also been progressively removing restrictions to foreign direct investment (FDI). According to the United Nations, between 1991 and 1996, more than 100 countries made 599 changes in legislation governing FDI. Some 95 percent of these changes involved liberalizing a country's foreign investment regulations to make it easier for foreign companies to enter their markets. The desire to facilitate FDI has also been reflected in a dramatic increase in the number of bilateral investment treaties designed to protect and promote investment between two countries. As of January 1, 1997, there were 1,330 such treaties in the world involving 162 countries, a threefold increase in five years.

Table 1.1

Average Tariff Rates on Manufactured Products as Percent of Value

	1913	1950	1990	2000*
France	21	18	5.9	3.9
Germany	20	26	5.9	3.9
Italy	18	25	5.9	3.9
Japan	30	--	5.3	3.9
Holland	5	11	5.9	3.9
Sweden	20	9	4.4	3.9
Britain	--	23	5.9	3.9
United States	44	14	4.8	3.9

*Rates for 2000 based on full implementation of Uruguay agreement.
Source: "Who Wants to Be a Giant?" The Economist: A Survey of the Multinationals, June 24, 1995,
pp. 3 - 4.

Figure 1.1

The Growth of World Trade and World Output

Source: WORLD TRADE ORGANIZATION. World Development Report 1998: Trends and Determinants

Such trends facilitate both the globalization of markets and the globalization of production. The lowering of barriers to international trade enables firms to view the world, rather than a single country, as their market. The lowering of trade and investment barriers also allows firms to base production at the optimal location for that activity, serving the world market from that location. Thus, a firm might design a product in one country, produce component parts in two other countries, assemble the product in yet another country, and then export the finished product around the world.

There is plenty of evidence that the lowering of trade barriers has facilitated the globalization of production. According to data from the World Trade Organization, the volume of world trade has grown consistently faster than the volume of world output since 1950.¹¹ Figure 1.1 gives data for 1950 to 1997. Over this period, world trade has expanded sixteen fold, far outstripping world output, which has grown six fold. As suggested by Figure 1.1, the growth in world trade seems to have accelerated in recent years.

The data summarized in Figure 1.1 imply two things. First, more firms are doing what Boeing does with the 777, dispersing parts of their overall production process to different locations around the globe to drive down production costs and increase product quality. Second, the economies of the world's nation-states are becoming more intertwined. As trade expands, nations are becoming increasingly dependent on each other for important goods and services.

The evidence also suggests that foreign direct investment is playing an increasing role in the global economy as firms ranging in size from Boeing to Swan Optical and Harry Ramsden's increase their cross-border investments. Between 1984 and 1997, the total annual flow of FDI from all countries increased tenfold from $42 billion to $430 billion, more than twice as fast as the growth rate in world trade.¹² The major investors have been US, Japanese, and Western European companies investing in Europe, Asia (particularly China), and the United States. For example, Japanese auto companies have been investing rapidly in Asian, European, and US-based auto assembly operations.

Finally, the globalization of markets and production and the resulting growth of world trade, foreign direct investment, and imports all imply that firms are finding their home markets under attack from foreign competitors. This is true in Japan, where US companies such as Kodak, Procter & Gamble, and Merrill Lynch are expanding their presence. It is true in the United States, where Japanese automobile firms have taken market share away from General Motors and Ford. And it is true in Europe, where the once-dominant Dutch company Philips has seen its market share in the consumer electronics industry taken by Japan's JVC, Matsushita, and Sony.

The bottom line is that the growing integration of the world economy into a single, huge marketplace is increasing the intensity of competition in a range of manufacturing and service industries.

Having said all this, declining trade barriers can't be taken for granted. As we shall see in the following chapters, demands for "protection" from foreign competitors are still often heard in countries around the world, including the United States. Although a return to the restrictive trade policies of the 1920s and 30s is unlikely, it is not clear whether the political majority in the industrialized world favors further reductions in trade barriers. If trade barriers decline no further, at least for the time being, a temporary limit may have been reached in the globalization of both markets and production.

The Role of Technological Change

The lowering of trade barriers made globalization of markets and production a theoretical possibility, and technological change has made it a tangible reality. Since the end of World War II, the world has seen major advances in communications, information processing, and transportation technology including, most recently, the explosive emergence of the Internet and World Wide Web. In the words of Renato Ruggiero, director general of the World Trade Organization,

Telecommunications is creating a global audience. Transport is creating a global village. From Buenos Aires to Boston to Beijing, ordinary people are watching MTV, they're wearing Levi's jeans, and they're listening to Sony Walkmans as they commute to work.13

Microprocessors and Telecommunications

Perhaps the single most important innovation has been development of the microprocessor, which enabled the explosive growth of high-power, low-cost computing, vastly increasing the amount of information that can be processed by individuals and firms. The microprocessor also underlies many recent advances in telecommunications technology. Over the past 30 years, global communications have been revolutionized by developments in satellite, optical fiber, and wireless technologies, and now the Internet and the World Wide Web. These technologies rely on the microprocessor to encode, transmit, and decode the vast amount of information that flows along these electronic highways. The cost of microprocessors continues to fall, while their power increases (a phenomenon known as Moore's Law, which predicts that the power of microprocessor technology doubles and its cost of production falls in half every 18 months).14 As this happens, the costs of global communications are plummeting, which lowers the costs of coordinating and controlling a global organization.

The Internet and World Wide Web

The phenomenal recent growth of the Internet and the associated World Wide Web (which utilizes the Internet to communicate between World Wide Web sites) is the latest expression of this development. In 1990, fewer than 1 million users were connected to the Internet. By mid-1998 the Internet had about 147 million users, of which some 70 million were in the United States. By the year 2000, the Internet may have over 330 million users.15 In July 1993, some 1.8 million host computers were connected to the Internet (host computers host the Web pages of local users). By July 1998, the number of host computers had increased to 36.8 million, and the number is still growing rapidly.16

The Internet and World Wide Web (WWW) promise to develop into the information backbone of tomorrow's global economy. From virtually nothing in 1994, the value of Web-based transactions hit $7.5 billion in 1997. According to a recent report issued by the United States Department of Commerce, this figure could reach $300 billion in the United States alone by 2003.17 Companies such as Dell Computer are booking over $4 million a day in Web-based sales, while Internet equipment giant Cisco Systems books more than $20 million per day in Web-based sales transactions. Viewed globally, the Web is emerging as the great equalizer. It rolls back some of the constraints of location, scale, and time zones. The Web allows businesses, both small and large, to expand their global presence at a lower cost than ever before. One example is a small California-based start-up, Cardiac Science, which makes defibrillators and heart monitors. In 1996, Cardiac Science was itching to break into international markets but had little idea of how to establish an international presence. By 1998, the company was selling to customers in 46 countries and foreign sales accounted for 85 percent of its $1.2 million revenues. Although some of this business was developed through conventional export channels, a growing percentage of it came from "hits" to the company's Web site, which according to the company's CEO, "attracts international business people like bees to honey."18 The Web makes it much easier for buyers and sellers to find each other, wherever they may be located, and whatever their size.

Transportation Technology

In addition to developments in communications technology, several major innovations in transportation technology have occurred since World War II. In economic terms, the most important are probably the development of commercial jet aircraft and superfreighters and the introduction of containerization, which simplifies transshipment from one mode of transport to another. The advent of commercial jet travel, by reducing the time needed to get from one location to another, has effectively shrunk the globe (see Figure 1.2). In terms of travel time, New York is now "closer" to Tokyo than it was to Philadelphia in the Colonial days.

Containerization has revolutionized the transportation business, significantly lowering the costs of shipping goods over long distances. Before the advent of containerization, moving goods from one mode of transport to another was very labor intensive, lengthy, and costly. It could take days and several hundred longshoremen to unload a ship and reload goods onto trucks and trains. With the advent of widespread containerization in the 1970s and 1980s, the whole process can be executed by a handful of longshoremen in a couple of days. Since 1980, the world's containership fleet has more than quadrupled, reflecting in part the growing volume of international trade and in part the switch to this mode of transportation. As a result of the efficiency gains associated with containerization, transportation costs have plummeted, making it much more economical to ship goods around the globe, thereby helping to drive the globalization of markets and production. In the United States, for example, the cost of shipping freight per ton mile on railroads has fallen from 3 cents in 1985 to 2.4 cents in 1997, largely as a result of efficiency gains from the widespread use of containers.19

Implications for the Globalization of Production

Due to containerization, the transportation costs associated with the globalization of production have declined. Plus, as a result of the technological innovations discussed above, the real costs of information processing and communication have fallen dramatically in the past two decades. This makes it possible for a firm to manage a globally dispersed production system, further facilitating the globalization of production. A worldwide communications network has become essential for many international businesses. For example, Texas Instruments (TI), the US electronics firm, has approximately 50 plants in 19 countries. A satellite-based communications system allows TI to coordinate, on a global scale, its production planning, cost accounting, financial planning, marketing, customer service, and personnel management. The system consists of more than 300 remote job-entry terminals, 8,000 inquiry terminals, and 140 mainframe computers. The system enables managers of TI's worldwide operations to send vast amounts of information to each other instantaneously and to coordinate the firm's different plants and activities.20

Another US electronics firm, Hewlett-Packard, uses satellite communications and information processing technologies to link its worldwide operations. Hewlett-Packard has new-product development teams composed of individuals based in different countries (e.g., Japan, the United States, Great Britain, and Germany). When developing new products, these individuals use videoconferencing to "meet" on a weekly basis. They also communicate with each other daily via telephone, electronic mail, and fax. Communication technologies have enabled Hewlett-Packard to increase the integration of its globally dispersed operations and to reduce the time needed for developing new products.21

The development of commercial jet aircraft has also helped knit together the worldwide operations of many international businesses. Using jet travel, an American manager need spend a day at most traveling to her firm's European or Asian operations. This enables her to oversee a globally dispersed production system.

Implications for the Globalization of Markets

In addition to the globalization of production, technological innovations have also facilitated the globalization of markets. As noted above, low-cost transportation has made it more economical to ship products around the world, thereby helping to create global markets. Low-cost global communications networks such as the World Wide

We must be careful not to overemphasize this trend. While modern communications and transportation technologies are ushering in the "global village," very significant national differences remain in culture, consumer preferences, and business practices. A firm that ignores differences between countries does so at its peril. We shall stress this point repeatedly throughout this book and elaborate on it in later chapters.