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The Changing Demographics of the Global Economy Hand in hand with the trend toward globalization has been a fairly dramatic change in the demographics of the global economy over the past 30 years or so. As late as the 1960s, four stylized facts described the demographics of the global economy. The first was US dominance in the world economy and world trade picture. The second was US dominance in world foreign direct investment. Related to this, the third fact was the dominance of large, multinational US firms on the international business scene. The fourth was that roughly half the globe--the centrally planned economies of the Communist world--was off-limits to Western international businesses. As will be explained below, all four of these qualities either have changed or are now changing rapidly. The Changing World Output and World Trade Picture In the early 1960s, the United States was still by far the world's dominant industrial power. In 1963, for example, the United States accounted for 40.3 percent of world output. By 1996, the United States accounted for only 20.8 percent (see Table 1.2). Nor was the United States the only developed nation to see its relative standing slip. Table 1.2 The Changing Pattern of World Output and Trade Source: Export data from World Trade Organization, International Trade Trends and Statistics, 1996. World Output data from CIA Factbook, 1996 (1995 world output figures are estimates).
* 1963 figure for Germany refers to the former West Germany. ** Output is measured by gross national product. *** The 1997 estimates are based on purchasing power parity (PPP) statistics that adjust GNP for differences in prices (the cost of living) between countries. § The Chinese figures are somewhat suspect. When calculated using unadjusted GNP data, China's share of world output shrinks to 3.1%. Thus, China's high share of world output on a PPP basis is partly due to the relatively low cost of living in China. The same occurred to Germany, France, and the United Kingdom, all nations that were among the first to industrialize. This decline in the US position was not an absolute decline, since the US economy grew at a relatively robust average annual rate of close to 3.0 percent in the 1963 - 96 time period (the economies of Germany, France, and the United Kingdom also grew over the time period). Rather, it was a relative decline, reflecting the faster economic growth of several other economies, particularly in Asia. For example, as can be seen from Table 1.2, over the 1963 - 96 time period, Japan's share of world output increased from 5.5 percent to 8.3 percent. Other countries that markedly increased their share of world output included China, Thailand, Malaysia, Taiwan, and South Korea. By virtue of its huge population and rapid industrialization, China in particular is emerging as an economic colossus. The Changing Foreign Direct Investment Picture Reflecting the relative decline in US dominance, by the end of the 1980s, its position as the world's leading exporter was threatened. Over the past thirty years, US dominance in export markets has waned as Japan, Germany, and a number of newly industrialized countries such as South Korea and China have taken a larger share of world exports. During the 1960s, the United States routinely accounted for 20 percent of world exports of manufactured goods. Table 1.2 also reports manufacturing exports as a percentage of the world total in 1997. As can be seen, the US share of world exports of manufactured goods had slipped to 12.6 percent by 1997. But despite the fall, the United States still remained the world's largest exporter, ahead of Germany and Japan. In 1997 and 1998 the dynamic economies of the Asian Pacific region were hit by a serious financial crisis that threatened to slow their economic growth rates for several years. Despite this, their powerful growth may continue over the long run, as will that of several other important emerging economies in Latin America (e.g., Brazil) and Eastern Europe (e.g., Poland). Thus, a further relative decline in the share of world output and world exports accounted for by the United States and other long-established developed nations seems likely. By itself, this is not a bad thing. The relative decline of the United States reflects the growing economic development and industrialization of the world economy, as opposed to any absolute decline in the health of the US economy, which in the late 1990s was stronger than it had ever been. Notwithstanding the financial crisis that is gripping some Asian economies, if we look 20 years into the future, most forecasts now predict a rapid rise in the share of world output accounted for by developing nations such as China, India, Indonesia, Thailand, South Korea, and Brazil, and a commensurate decline in the share enjoyed by rich industrialized countries such as Britain, Germany, Japan, and the United States. The World Bank, for example, has estimated that if current trends continue for the next quarter of a century, by 2020 the Chinese economy could be 40 percent larger than that of the United States, while the economy of India will be larger than that of Germany. Moreover, the bank estimates that today's developing nations may account for over 60 percent of world economic activity by 2020, while today's rich nations, which currently account for over 55 percent of world economic activity, may account for only about 38 percent by 2020.22 These forecasts suggest that a dramatic shift in the economic geography of the world is now under way. For international businesses, the implications of this changing economic geography are clear; many of tomorrow's economic opportunities may be found in the developing nations of the world, and many of tomorrow's most capable competitors will probably also emerge from these regions. Reflecting the dominance of the United States in the global economy, US firms accounted for 66.3 percent of worldwide foreign direct investment flows in the 1960s. British firms were second, accounting for 10.5 percent, while Japanese firms were a distant eighth, with only 2 percent. The dominance of US firms was so great that in Europe, books were written about the economic threat posed to Europe by US corporations.23 Several European governments, most notably that of France, talked of limiting inward investment by US firms in their economies. However, as the barriers to the free flow of goods, services, and capital fell, and as other countries increased their shares of world output, non-US firms increasingly
Figure 1.3 Percentage Share of Total FDI Stock, 1980 - 1996 Source: Data are taken from the United Nations, World Investment Report, 1997 (New York: United Nations, 1997). began to invest across national borders. The motivation for much of this foreign direct investment by non-US firms was the desire to disperse production activities to optimal locations and to build a direct presence in major foreign markets. Thus, during the 1970s and 80s, European and Japanese firms began to shift labor-intensive manufacturing operations from their home markets to developing nations where labor costs were lower. In addition, many Japanese firms have invested in North America and Europe--often as a hedge against unfavorable currency movements and the possible imposition of trade barriers. For example, Toyota, the Japanese automobile company, rapidly increased its investment in automobile production facilities in the United States and Britain during the late 1980s and early 1990s. Toyota executives believed that an increasingly strong Japanese yen would price Japanese automobile exports out of foreign markets; therefore, production in the most important foreign markets, as opposed to exports from Japan, made sense. Toyota also undertook these investments to head off growing political pressures in the United States and Europe to restrict Japanese automobile exports into those markets. One consequence of these developments is illustrated in Figure 1.3, which shows how the stock of foreign direct investment by the world's six most important national sources--the United States, Britain, Japan, Germany, France, and the Netherlands--changed between 1980 and 1996. (The stock of foreign direct investment refers to the total cumulative value of foreign investments.) Figure 1.3 also shows the stock accounted for by firms from other developed nations and from developing economies. As can be seen, the share of the total stock accounted for by US firms declined substantially from around 44 percent in 1980 to 25 percent in 1996. Meanwhile, the shares accounted for by Japan, France, other developed nations, and the world's developing nations increased markedly. The rise in the share for developing nations reflects a small but growing trend for firms from these countries, such as South Korea, to invest outside their borders. In 1996 firms based in developing nations accounted for 8.9 percent of the stock of foreign direct investment, up from only 1.2 percent in 1980. Figure 1.4 illustrates another important trend--the increasing tendency for cross-border investments to be directed at developing rather than rich industrialized nations. Figure 1.4 details recent changes in the annual inflows of foreign direct investment (the flow of foreign direct investment refers to amounts invested across
Figure 1.4 FDI Inflows, 1985 - 1997 (in US$ billions) Source: United Nations, World Development Report, 1998: Trends and Determinants. national borders each year). What stands out in Figure 1.4 is the increase in the share of foreign direct investment inflows accounted for by developing countries during the 1990s, and the commensurate decline in the share of inflows directed at developed nations. In 1997, foreign direct investment inflows into developing nations hit a record $149 billion, or 37 percent of the total, up from just $42 billion in 1991, or 26 percent of the total. Among developing nations, China has received the greatest volume of inward FDI in recent years. China took a record $45 billion out of the investment that went to developing nations in 1997. Other developing nations receiving a large amount of FDI in 1997 were Indonesia, Malaysia, the Philippines, Thailand, and Mexico. At the other end of the spectrum, the smallest 100 recipient countries accounted for just 1 percent of all FDI inflows.24 Foreign investment into developing nations is focused on a relatively small group of countries experiencing rapid industrialization and economic growth. Businesses investing in these nations are positioning themselves to be active participants in those areas of the world that are expected to grow most rapidly over the next quarter of a century. The Changing Nature of the Multinational Enterprise A multinational enterprise is any business that has productive activities in two or more countries. Since the 1960s, there have been two notable trends in the demographics of the multinational enterprise: (1) the rise of non-US multinationals, particularly Japanese multinationals, and (2) the growth of mini-multinationals. Non-US Multinationals In the 1960s, global business activity was dominated by large US multinational corporations. With US firms accounting for about two-thirds of foreign direct investment during the 1960s, one would expect most multinationals to be US enterprises. According to the data presented in Table 1.3, in 1973, 48.5 percent of the world's 260 largest multinationals were US firms. The second-largest source country was Great Britain, with 18.8 percent of the largest multinationals. Japan accounted for only 3.5 percent of the world's largest multinationals at the time. The large number of US Table 1.3 The National Composition of the Largest Multinationals Source: Figures for 1973 from Neil Hood and John Young, The Economics of the Multinational Enterprise (New York: Longman, 1979). Figures for 1997 from "The Global 500," Fortune, August 4, 1997, pp. 130 - 31.
multinationals reflected US economic dominance in the three decades after World War II, while the large number of British multinationals reflected that country's industrial dominance in the early decades of the 20th century. By 1997, however, things had shifted significantly. US firms accounted for 32.4 percent of the world's 500 largest multinationals, followed closely by Japan with 25.2 percent. France was a distant third with 8.4 percent. Although the two sets of figures in Table 1.3 are not strictly comparable (the 1973 figures are based on the largest 260 firms, whereas the 1997 figures are based on the largest 500 firms), they illustrate the trend. The globalization of the world economy together with Japan's rise to the top rank of economic powers have resulted in a relative decline in the dominance of US (and, to a lesser extent, British) firms in the global marketplace. Table 1.4 adds detail to this picture by listing the largest 25 multinational corporations ranked by foreign assets in 1996. Six of the top 25 are US enterprises, four are Japanese, five are German, three are French, three are Swiss, two are jointly incorporated in the United Kingdom and the Netherlands. The remainder are accounted for by the Netherlands and Italy. Looking to the future, we can reasonably expect growth of new multinational enterprises from the world's developing nations. As the accompanying Country Focus demonstrates, South Korean firms are starting to invest outside their national borders. The South Koreans may soon be followed by firms from countries such as Mexico, China, Russia, and Brazil. The Rise of Mini-Multinationals Another trend in international business has been the growth of medium-sized and small multinationals (mini-multinationals). When people think of international businesses they tend to think of firms such as Exxon, General Motors, Ford, Fuji, Kodak, Matsushita, Procter & Gamble, Sony, and Unilever--large, complex multinational corporations with operations that span the globe. Although it is certainly true that most international trade and investment is still conducted by large firms, it is also true that many medium-sized and small businesses are becoming increasingly involved in international trade and investment. We have already discussed several examples in this chapter--Swan Optical, Harry Ramsden's, and Cardiac Science--and we have noted how the rise of the Internet is lowering the barriers that small firms face in building international sales. For another example, consider Lubricating Systems, Inc., of Kent, Washington. Lubricating Systems, which manufactures lubricating fluids for machine tools, employs 25 people and generates sales of $6.5 million. Hardly a large, complex multinational, yet more than $2 million of the company's sales are generated by exports to a score of countries from Japan to Israel and the United Arab Emirates. Lubricating Systems also has set up a joint venture with a German company to serve the European market.25 Consider also Lixi, Inc., a small US manufacturer of industrial X-ray equipment; 70 percent of Lixi's $4.5 million in revenues come from exports to Japan.26 Or take G. W. Barth, a manufacturer of cocoa-bean roasting machinery based in Ludwigsburg, Germany. Employing just 65 people, this small company has captured 70 percent of the global market for cocoa-bean roasting machines.27 The point is, international business is conducted not just by large firms but also by medium-sized and small enterprises.
Table 1.4 The Top 25 Multinational Businesses in 1996 (ranked by foreign assets) Source: Adapted from Table 1.7 in United Nations, World Investment Report, 1997 (New York and Geneva: United Nations 1997). The Changing World Order Between 1989 and 1991 a series of remarkable democratic revolutions swept the communist world. For reasons that are explored in more detail in Chapter 2, in country after country throughout Eastern Europe and eventually in the Soviet Union itself, Communist governments collapsed like the shells of rotten eggs. The Soviet Union is now history, having been replaced by 15 independent republics. Czechoslovakia has divided itself into two states, while Yugoslavia has dissolved into a bloody civil war among its five successor states. Many of the former communist nations of Europe and Asia seem to share a commitment to democratic politics and free market economics. If this continues, the opportunities for international businesses may be enormous. For the best part of half a century, these countries were essentially closed to Western international businesses. Now they present a host of export and investment opportunities. Just how this will play out over the next 10 to 20 years is difficult to say. The economies of most of the former communist states are in very poor condition, and their continued commitment to democracy and free market economics cannot be taken for granted. Disturbing signs of growing unrest and totalitarian tendencies are seen in many Eastern European states. Thus, the risks involved in doing business in such countries are very high, but then, so may be the returns. In addition to these changes, more quiet revolutions have been occurring in China and Latin America. Their implications for international businesses may be just as profound as the collapse of communism in Eastern Europe. China suppressed its own prodemocracy movement in the bloody Tiananmen Square massacre of 1989. Despite this, China seems to be moving progressively toward greater free market reforms. The southern Chinese province of Guangdong, where these reforms have been pushed the furthest, now frequently ranks as the fastest-growing economy in the world.28 If what is now occurring in southern China continues, and particularly if it spreads throughout the country, China may move from Third World to industrial superpower status even more rapidly than Japan did. If China's GDP per capita grows by an average of 6 percent to 7 percent, which is slower than the 8 percent growth rate achieved during the last decade, then by 2020 this nation of 1.2 billion people could boast an average income per capita of about $13,000, roughly equivalent to that of Spain today. The potential consequences for Western international business are enormous. On the one hand, with 1.2 billion people, China represents a huge and largely untapped market. Reflecting this, between 1983 and 1997, annual foreign direct investment in China increased from less than $2 billion to $45 billion. On the other hand, China's new firms are proving to be very capable competitors, and they could take global market share away from Western and Japanese enterprises. Thus, the changes in China are creating both opportunities and threats for established international businesses. As for Latin America, here too both democracy and free market reforms seem to have taken hold. For decades, most Latin American countries were ruled by dictators, many of whom seemed to view Western international businesses as instruments of imperialist domination. Accordingly, they restricted direct investment by foreign firms. In addition, the poorly managed economies of Latin America were characterized by low growth, high debt, and hyperinflation--all of which discouraged investment by international businesses. Now all this seems to be changing. Throughout most of Latin America, debt and inflation are down, governments are selling state-owned enterprises to private investors, foreign investment is welcomed, and the region's economies are growing rapidly. These changes have increased the attractiveness of Latin America, both as a market for exports and as a site for foreign direct investment. At the same time, given the long history of economic mismanagement in Latin America, there is no guarantee that these favorable trends will continue. As in the case of Eastern Europe, substantial opportunities are accompanied by substantial risks. In sum, the last quarter of century has seen rapid changes in the global economy. Barriers to the free flow of goods, services, and capital have been coming down. The volume of cross-border trade and investment has been growing more rapidly than global output, indicating that national economies are become more closely integrated into a single, interdependent, global economic system. As their economies advance, more nations are joining the ranks of the developed world. A generation ago, South Korea and Taiwan were viewed as second-tier developing nations. Now they boast powerful economies, and their firms are major players in many global industries from shipbuilding and steel to electronics and chemicals. The move toward a global economy has been further strengthened by the widespread adoption of liberal economic policies by countries that for two generations or more were firmly opposed to them. Thus, following the normative prescriptions of liberal economic ideology, in country after country we are seeing state-owned businesses privatized, widespread deregulation, markets being opened to more competition, and increased commitment to removing barriers to cross-border trade and investment. This suggests that over the next few decades, countries such as the Czech Republic, Poland, Brazil, China, and South Africa may build powerful market-oriented economies. In short, current trends suggest that the world is moving rapidly toward an economic system that is more favorable for the practice of international business. On the other hand, it is always hazardous to take established trends and use them to predict the future. The world may be moving toward a more global economic system, but globalization is not inevitable. Countries may pull back from the recent commitment to liberal economic ideology if their experiences do not match their expectations. There are signs, for example, of a retreat from liberal economic ideology in Russia. Russia has experienced considerable economic pain as it tries to shift from a centrally planned economy to a market economy. If Russia's hesitation were to become more permanent and widespread, the liberal vision of a more prosperous global economy based on free market principles might not come to pass as quickly as many hope. Clearly, this would be a tougher world for international businesses to compete in. Moreover, greater globalization brings with it risks of its own. This was starkly demonstrated in 1997 and 1998 when a financial crisis in Thailand spread first to other East Asian nations and then in 1998 to Russia and Brazil. Ultimately the crisis threatened to plunge the economies of the developed world, including the United States, into a recession. We explore the causes and consequences of this and other similar global financial crises later in this book (see Chapters 10 and 11). For now it is simply worth noting that even from a purely economic perspective, globalization is not all good. The opportunities for doing business in a global economy may be significantly enhanced, but as we saw in 1997 - 98, the risks associated with global financial contagion are also greater. Still, as explained later in this book, there are ways for firms to exploit the opportunities associated with globalization, while at the same time reducing the risks through appropriate hedging strategies. |
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