We estimate that the current wave of globalisation is responsible for around a third of the pick-up in global per capita income growth since 1990. Almost all of that reflects an improvement in productivity growth in emerging economies. For advanced economies, globalisation has had a marked impact on the distribution of income, but the effect on aggregate growth has been small. That suggests emerging markets would be at far greater risk if globalisation were to go into reverse.
- We estimate that the current wave of globalisation is responsible for around a third of the pick-up in global per capita income growth since 1990. Almost all of that reflects an improvement in productivity growth in emerging economies. For advanced economies, globalisation has had a marked impact on the distribution of income, but the effect on aggregate growth has been small. That suggests emerging markets would be at far greater risk if globalisation were to go into reverse.
- The surge in trade integration over the past 30 years has made its biggest mark in emerging economies. Trade has been key for developing large manufacturing sectors, with the splitting of supply chains allowing even relatively small emerging markets to benefit from economies of scale and achieve global reach. An influx of investment and production know-how from Western firms has spilled over to local firms, raising investment and boosting labour productivity across the board.
- Of course, that turnaround has only been possible thanks to the political transformation that had previously taken place across the emerging world. Countries which have failed to put in place the right policies, notably Russia and much of Africa, have lagged behind. While it is difficult to estimate with any precision, we think that expanded trade accounts for perhaps half of the acceleration in productivity growth in emerging markets over the past twenty five years. That is equivalent to a 1.5% boost to per capita incomes per annum. That in turn equates to a 0.3%-pt boost to global per capita income growth, accounting for one-third of the overall pick-up from 1.5%% y/y in the 1980s to 2.5% y/y since 2000.
- For advanced economies, by contrast, the net effect of globalisation has been small. Trade has transformed the supply side of the economy, all but eliminating production in some lower value added industries while providing a big boost to higher value added sectors. While that has lifted productivity growth, the impact has been modest. For advanced economies at the frontier, the far more important driver of growth is technological change, the impact of which appears to have waned over the past decade or so.
- Even the modest gains from trade to the supply side of advanced economies were partly offset by a shortfall in demand as a result of idled factories and unemployed workers in import-competing sectors. All that has meant the main lasting impact of globalisation in advanced economies has been on the distribution of income, boosting capital income at the expense of labour.
- Globalisation is frequently credited with putting downward pressure on inflation, but we suspect it has played only a minor role. The wave of cheap imports flooding advanced economies did have a notable impact on goods prices, but the far bigger deflationary force over the past forty years has been in services. That occurred mainly in the 1980s before globalisation really got going and reflects the introduction of more credible inflation targeting monetary policy, the demise of trade unions and technological change.
- While not the only factor, globalisation has played an important role in the favourable performance of the world economy over the past 25 years. Over a longer horizon, it seems likely that globalisation has generated wider benefits by boosting competition, promoting domestic liberalisation and helping to avoid “beggar thy neighbour” policies, particularly after the global financial crisis. A reversal of globalisation would not necessarily mean those benefits would be lost. But they would be harder to sustain.
Globalisation and its effects on the world economy
The world has seen three distinct waves of globalisation over the past 150 years, with the most recent taking off in the 1990s and centred on the expansion of cross-border supply chains and the re-integration of major emerging markets into the global economy. There can be little doubt that this process has fundamentally reshaped the world economy, but less clear is the net impact that has had on overall economic growth and inflation over the past quarter of a century. In this Focus, we dissect the ways in which globalisation can be thanked (or blamed) for recent economic performance. We also consider whether other factors played a more important role.
This Focus is part of a series of reports about the end of globalisation and the impact of this on the global economy and financial markets. These can be found at https://www.capitaleconomics.com/the-end-of-globalisation/
The gains from trade in theory…
Ask three economists a question and you will get five different answers, or so the joke goes. But when it comes to globalisation, there is a broad consensus that the fewer barriers to trade, the better. That conclusion is founded on Adam Smith’s argument that trade enables greater specialisation. David Ricardo showed how, through comparative advantage, countries with low productivity can gain by specialising in what they produce relatively cheaply and trading the surplus. By allowing resources to flow to where they are most productive, trade boosts economic potential in every country.
Those classical trade theories do show that trade generates winners and losers within economies. Access to cheaper, better, or entirely new categories of imported goods benefits consumers, while producers in exporting industries receive a boost to demand. But workers and owners of capital in sectors facing new competition from imports suffer.
Under perfect competition and frictionless markets, the gains outweigh the costs. But in the real world, we know that adjustments are not immediate. It can be years or even lifetimes before idle factories, machinery and laid off workers find alternative work. The difficultly of compensating the ‘losers’ means trade shocks may result in long-lasting unemployment. In the short term at least, the net impact of trade on economic growth is ambiguous.
Muddying the picture further, a rising share of trade takes place in industries with increasing returns to scale, or that generate significant spillovers to the rest of the economy. The entertainment industry, web-based services or high end manufacturing are all good examples. In these industries, as trade expands, big up-front costs can be spread over a larger number of sales, making established firms even more productive, generating a virtuous upward spiral in jobs and investment for the areas which play host to those industries. All that means the latest wave of globalisation has generated bigger winners, while the losers found it increasingly difficult to enter new markets.
There are two common misconceptions that should be corrected at the outset. The first is that a rise in exports can boost demand and thus growth at a global level. They cannot, since for every export there must be an offsetting import. The second is that individual countries that run trade or current account surpluses are somehow better off in terms of growth or income than those that run deficits. Other than in the very short run, they are not (despite what President Donald Trump might claim). Instead, the way that increased openness to trade boosts growth is by enabling a more efficient allocation of resources.
…and in practice
Chart 1 highlights the speed and scale of globalisation over the past 30 years. Global exports have risen rapidly, reaching 25% of GDP from below 15% in 1990. (For much more detail, see our previous Focus on the history of globalisation here.)
Chart 1: World Export Volumes As a Share of GDP (%)
Source: Fouquin & Hugot (2016)
The surge in trade integration over the past quarter of a century coincided with a significant acceleration in global economic growth. World per capita GDP growth, which had averaged less than 1.5% in the 1980s, began accelerating in the mid-1990s and averaged more than 2.5% per year in the 2000s. (See Chart 2.)
Chart 2: World Per Capita GDP (% y/y)
Sources: Maddison, IMF
Despite the lingering impact of the 2008 global financial crisis, growth has been comparatively strong in the 2010s too. The past two decades have witnessed the strongest sustained performance of the global economy since the “golden age” of the 1960s when the West was reintegrating in the aftermath of World War II.
However, that acceleration hasn’t been felt in every economy. Per capita growth in advanced economies slowed in the 2000s and has remained sluggish in the 2010s. What really stands out is the marked (and unprecedented) outperformance of today’s emerging economies. (See Chart 3.)
Chart 3: Per Capita GDP (% y/y)
Sources: World Bank, Capital Economics
At the country level, there has been a positive relationship between integrating into global markets and economic growth over this period, albeit only a loose one. Economies that increased exports as a share of output by 10 percentage points between 1990 and 2014 grew on average 0.2%-pts faster per year. (See Chart 4.)
Chart 4: Average Per Capita GDP Growth & Change in Export-to-GDP Ratio, 1990-2014
Sources: IMF, CEPII, Capital Economics
At face value then, there does seem to be some evidence in the data of a link between globalisation and improved economic performance. However, these simple relationships are potentially misleading. Both improved economic performance and globalisation may have been driven by other factors – such as the pace of technological innovation or domestic policy reforms. Academic studies that attempt to measure the impact of greater trade on economic performance also struggle to isolate the contribution from increased trade for precisely this reason – countries opening up to trade often undertake liberalising domestic reforms which also affect economic growth.
In the following sections, we establish the channels through which globalisation has contributed to the relative strength of the global economy over the past 25 years.
Emerging markets have been the big beneficiaries
As Chart 3 made clear, emerging markets have enjoyed the greatest success during the rapid period of globalisation over the past twenty five years.
It is sometimes argued that the expansion of trade added directly to economic output in many emerging markets at the expense of advanced economies thanks to a big run-up in EMs’ trade surpluses. It is true that, as a group, emerging markets went from running a current account deficit of 1% of GDP annually in the late-1990s to running a surplus of 5% of GDP by 2006. (See Chart 5.) However, that has since been reversed, and, in any case, as we noted earlier, a larger trade surplus does not imply faster growth.
Chart 5: Emerging Markets Current Account (% GDP)
Instead, the gains for emerging economies from trade have come through labour productivity growth, which has accelerated markedly. For most countries, that surge has been concentrated in the manufacturing sector. (See Chart 6.) Manufacturing lends itself to rapid productivity growth because cutting edge technologies and machinery can be copied relatively easily, and as processes tend to be standardised, they are easy to scale up and replicate across the country.
Chart 6: EM Output Per Worker (% y/y, 2000-2015 Ave.)
Sources: OECD, Capital Economics
Physical manufactured products are easily tradable and so open up a big market to producers well beyond national borders. The latest wave of globalisation has been driven by the splitting of global supply chains, breaking up large, complex processes into smaller chunks. That has enabled even the smallest emerging markets, for example Hong Kong, Singapore and Taiwan, to achieve sufficient scale and world-class proficiency in certain industries.
Western firms, lured by low labour costs, piled investment into emerging economies. Foreign direct investment into emerging economies averaged around 3% of GDP annually during the 2000s. (See Chart 7.) Much of that was geared towards building new production facilities. That sustained investment meant the stock of FDI rose sharply, doubling as a share of GDP in emerging Asia between 1995 and 2015.
Chart 7: Value of Inward FDI in EMs
Sources: UNCTAD, Capital Economics
Perhaps more important than the investment itself was the introduction of new technologies and production techniques, boosting productivity growth. Not all of that knowledge is firm-specific, with new techniques and technologies diffusing from Western firms to local producers. That process occurs naturally as managers and workers get exposed to new ideas and ways of operating, but direct theft and violation of intellectual property rights may also have helped grease the wheels of knowledge diffusion.
Increased export opportunities also encouraged domestic firms in China and other export-orientated emerging economies to invest more and integrate themselves into global supply chains, further boosting investment and exports.
Of course, the surge in trade and investment into emerging markets did not occur in a vacuum. This turnaround was only possible as a result of huge economic and political transformation that had previously taken place across the emerging world. The most important, of course, was the opening up of China. Elsewhere, the collapse of communism in Emerging Europe led to the rebuilding of market economies. Similarly, the overthrow of military dictatorships and the restoration of democracies in Latin America paved the way for economic reforms that stabilised public finances, defeated hyperinflation and liberalised domestic markets, at least temporarily!
All of these were essentially one-off improvements which provided a big boost to the productive potential of emerging economies in the 1990s and 2000s. There are exceptions of course. Russia is one prominent example where the government has failed to implemented policies to encourage foreign investment and trade and as a result has suffered from a stagnation in productivity growth. But in contrast to earlier periods, a substantial number of emerging markets now have a floating currency, an inflation-targeting central bank and a government that preaches fiscal discipline.
It is difficult to say with any precision just how much of the improvement in economic performance is due to trade and how much is thanks to improved domestic policymaking. At the risk of oversimplifying, empirical work on our emerging markets service shows that a one percentage point increase in trade as a share of GDP is associated with a 0.3 percentage point acceleration in GDP growth. Applying this rough rule of thumb to the past twenty five years for EMs suggests that increased trade added 1.5%-pts to annual economic growth in emerging economies, or fully half of the acceleration in economic growth in that period. We wouldn’t want to put too much emphasis on that precise figure, but the upshot is that globalisation has been an important, but not the only, factor behind the pick-up in EM growth over the past few decades.
We would not want to play down the wider interplay at work here either. Globalisation may itself have acted as a spur to liberalisation of domestic markets. There are many examples of this, such as in Eastern Europe, where the carrot of EU membership helped to anchor and spur on domestic reforms. A whole host of regional trade agreements, most notably the Trans-Pacific Partnership, have wide-ranging rules covering things like state aid and intellectual property rights. Trade agreements can be particularly useful tools in emerging economies where domestic politics are volatile, providing an internationally enforceable mechanism to keep weak domestic governments in line – a form of “good housekeeping seal of approval” which in turn helps to bolster confidence and investment in the domestic economy. Finally, by producing plenty of successful export-dependent businesses and jobs within emerging economies, trade liberalisation helped generate political support for further liberalisation in a virtuous upward cycle.
A small net positive for advanced economies
In contrast, it is less obvious that advanced economies have benefitted from the rapid globalisation of the 1990s and 2000s. As Chart 3 showed, per capita growth has remained much slower than in previous decades, suggesting that even if globalisation has had positive effects for advanced economies, it has not been the dominant force shaping the outlook.
Globalisation over the past quarter of a century has had two main impacts on advanced economies. On the consumer side of the economy, the expansion of trade has helped to hold down prices for a wide range of goods, effectively providing a terms of trade boost to real incomes and living standards. On the producer side of the economy, it has prompted a shift in output away from lower value added sectors and towards higher value added areas of production.
For consumers, globalisation appears to have been transformational in reducing prices for a range of goods. We can see that effect clearly in the US import prices data. Not only are import prices from emerging markets likely to be lower in the first place, but since 1991, the prices of imports from other advanced economies have risen by close to 50%, whereas those from emerging Asia have fallen by 30%. (See Chart 8.) The share of imports from Asia also rose sharply over this period.
Chart 8: US Import Prices (Jan 91 = 100)
That helps to explain why, after adding 1%-pts to annual inflation in the 1970s and 1980s, US core goods prices have fallen gently since 1990, subtracting 0.2%-pts from annual inflation. The figures are similar in the other major advanced economies. Not all of the decline in prices can be attributed solely to globalisation (more on that later) But its notable that the declines have been concentrated in consumer goods that are now mostly imported from emerging economies, namely clothing, electronics, furniture, and toys.
On the supply side, the expansion of trade with emerging economies has had a marked impact, boosting sectors that rely on their expertise and knowledge while undermining lower value added import-competing sectors. This has been most visible in manufacturing, and particularly pronounced in the United States. Beginning in 2001, when China joined the WTO, US manufacturing output growth slowed substantially and employment in the sector plummeted. (See Chart 9.) Manufacturing job losses in other advanced economies have been less dramatic, but the trends are similar.
Chart 9: US Manufacturing Output & Employment
Despite the fall in manufacturing employment, output continued to rise throughout the early 2000s. That suggests that automation and technological innovation were responsible for job losses too. But those factors cannot explain the downshift in the pace of output growth in manufacturing.
Moreover, it is clear that increased trade has played a key role in shifting output away from lower-value added sectors, and towards more sophisticated industries. Chart 10 highlights some of the most extreme examples for four advanced economies – the US, euro-zone, Japan and the UK. Output of vehicles, in which advanced economies still hold a comparative advantage, has more than doubled over the past few decades.
Chart 10: Output in US, Euro-zone, Japan & UK (Q1 1995 = 100)
Sources: Refinitiv, Capital Economics
By contrast, output in lower value added sectors, notably textiles has plummeted and now stands at just a third of its level in 1995. (Textiles have fared particularly poorly because the industry was protected by a vast system of import quotas which were gradually phased out from 1994 onwards.) Unsurprisingly, there has been a marked increase in the trade deficit with emerging markets in these goods.
If anything, these sectoral figures underplay the transformation witnessed over the past twenty five years, because there’s been an even greater transformation within industries. Supply chains have been completely reconfigured. For example, within the car industry, much of the production of auto parts has been outsourced to lower-cost countries, notably in Eastern Europe (Germany), Mexico (US) and China (Japan). The economic activity in autos and other high-end manufacturing industries that has remained in advanced economies is typically better paid, more specialised design and precision work.
All of that should have helped to lift productivity growth of the overall economy by shifting production to higher value added sectors. It’s difficult to quantify just how much that is due to globalisation specifically, but there is evidence that firms facing increased competition from China produced more patents, invested in new technology and saw faster productivity growth as a result. Estimates suggest that may account for up to a sixth of the productivity growth in Europe between 2000 and 2007. Those gains were driven both by firms adopting new technologies and because more technologically advanced firms gained market share.
Overall, it appears that, in the short-run at least, the boost to productivity is playing only a relatively minor role in advanced economies. As we’ve discussed in previous work (see here), the main driver of growth in economies at or close to the technology frontier is the pace of technological change. While there are signs of technological innovation all around us, productivity growth has slowed as the beneficial impact of the past technologies, mainly computers and the internet, is fading, while the impact of new mobile, AI and machine learning technologies has yet to be fully felt. Adding to the headwinds, the share of the population in advanced economies going to study tertiary education has slowed in recent years, and there are worrying signs that investment growth has been unusually weak in the wake of the financial crisis, perhaps reflecting increased risk aversion.
All these factors, which have little to do with international trade, explain the continued weakness of productivity growth in advanced economies. The fact that increased trade, which should have boosted productivity, does not appear to have had much impact on the aggregate figures suggests it is playing only a minor role.
Gains diluted by adjustment costs
In any case, the beneficial impact on the supply side of the economy was partly offset by a shortfall in demand as a result of those idled factories and unemployed workers in import-competing sectors. We don’t think that has been large enough to mean the net effect of globalisation has been negative for advanced economies. But it does appear to have offset some of the already modest benefits.
A seminal study by a team of labour economists showed that the rise in import share from China since 1999 reduced US manufacturing employment directly by 560,000. What’s more, factoring in the impact on suppliers increases the hit to 985,000, and a nearly equal number of jobs in the services sector. Because the jobs lost were concentrated in the mid-West and Appalachia in the US, they estimate the broader hit to demand in those geographical areas reduced overall employment by close to 2.4 million workers. This caused a lasting increase in both unemployment and underemployment in those local labour markets.
While that legacy still accounts for the underperformance of those regions today, it is harder to see a lasting macroeconomic impact for the US, or advanced economies overall. But that is in part because any shortfall in demand as a result of globalisation was offset during the 2000s by a substantial increase in credit. That is hardly reassuring, however, given that was arguably the underlying cause of the global financial crisis of 2008.
Moreover, even though unemployment rates in the US and most other advanced economies are now back at multi-year lows, there are still some scars from the rapid globalisation of the 2000s persisting today. For example, the share of people aged 25-54 in the US that are economically active is still 1.5%-pts below its peak in the late 1990s. (See Chart 11.)
Chart 11: US Labour Force Participation (%, Age 25-54)
Rather than weighing much on economic growth, the main lasting impact of this reconfiguration of demand has been on the distribution of income within advanced economies. As Chart 12 shows, the labour share of income in advanced economies, which had been trending lower for many years, fell particularly sharply in the 2000s after China joined the WTO.
The sectors that benefitted from increased demand as a result of globalisation are more capital and human-capital intensive, while the sectors that lost out were “job-rich”. Other factors have been important too, with automation, the demise of union power, and lower marginal income tax rates all playing important roles. But the timing of the sharp drop in the 2000s suggests that globalisation has played some role in the decline. This has of course had implications for income inequality, savings and investment and the neutral level of interest rates, but there’s little evidence that has held back the overall economy much.
Chart 12: Labour Share of Gross Income (%)
China joins WTO
Sources: St Louis Fed, Capital Economics
What’s been the impact on inflation?
Of course it’s not just economic growth that has been affected by globalisation. The process is often claimed to have had a profound impact on prices too. As we discussed earlier, a wave of cheap imports in the 1990s and 2000s did help generate deflation in goods prices in advanced economies, reducing annual inflation in the US by perhaps 1-1.5%-pts each year. That’s significant, but accounts for only part of the decline in inflation in advanced economies since the 1980s. (See Chart 13.)
Chart 13: CPI Inflation in Advanced Economies (%)
Sources: Refinitiv, Capital Economics
The much bigger decline has come from weaker services inflation, which in turn reflects a distinct downward shift in the Phillips curve relationship between unemployment and wages. (See Chart 14.) That big change occurred in the mid-1980s, before the latest wave of globalisation really got going, so it appears that other factors have been more important. In our view, the key drivers were more credible inflation-fighting central banks, led by Paul Volcker at the US Fed, the decline of trade union power, and technological changes which increased the ability of firms to substitute workers for capital.
Chart 14: Unemployment Rate & Wage Growth in G7
Sources: Refinitiv, Capital Economics
By greatly expanding the pool of global labour over the past few decades, globalisation has helped to weaken the bargaining power of workers in advanced economies a little further, evidenced by the continued flattening of the Phillips curve in the 2000s. But that effect has been modest compared to the shift in the 1980s.
Moreover, if globalisation were the only factor at work, we’d still expect there to be some relationship between wage growth and spare capacity at the global level. But the fact that wage growth has remained surprisingly muted during the synchronised global upswing seen in 2016-2018 suggests that those other factors are playing the key role.
The upshot is that globalisation has certainly helped to dampen inflationary pressures in advanced economies, but inflation was brought under control even before the latest wave of globalisation began. That in turn suggests that any unwinding of globalisation would not necessarily lead to a pick-up or acceleration in inflation in advanced economies.
Beyond the impact on economic output and inflation, globalisation has influenced wider trends in the global economy too. We’ve already discussed how trade has created winners and losers within economies, pushing down labour’s share of income and contributing to increased inequality. The flip side of that has been a rise in the share of income going to capital, providing a key support to asset prices over the past few decades. (For more discussion of the financial market implications, see our forthcoming Asset Allocation Focus.)
Deeper trade links and greater financial interconnectedness have blurred the boundaries between national and global economies. As a result, business cycles have become increasingly global, rather than national, driven by common shocks. Emerging economies, whose growth rates were uncorrelated with global growth in the 1960s and 1970s, now move far more tightly in line with the global business cycle. (See Chart 15.)
That is most vividly illustrated by the events of 2008, with the sub-prime crisis transmitted quickly across the rest of the globe. More recently, we saw a synchronised global upswing in 2017-18 on the back of the fading euro-zone crisis and fiscal stimulus in the US, followed by a similarly synchronised global downswing over the past year or so.
Chart 15: Correlation Between EM & Global Economic Growth (10-Year Rolling Average)
Sources: World Bank, Capital Economics
That interconnectedness may be one reason why financial crises appear to be becoming more frequent. (See Chart 16.) Financial crises were extremely rare during the post-war period, in which the Bretton Woods system constrained capital flows. But they started to become more frequent in the 1980s with the Latin American debt crises and in the 1990s with the Asian financial crisis. After a brief period of calm in the early 2000s, the world economy entered the global financial crisis and then the crisis in the euro-zone.
Chart 16: Share of Economies In a Financial Crisis (%)
Sources: Carmen Reinhart, Harvard Biz School. Sample of 80 economies.
Lax regulation and supervision, misaligned incentives and the rise of “too big to fail” institutions are all partly to blame for the spate of financial crises over the past thirty years. But we think globalisation has been an important part of the story too. That’s because, by making the system more complex and interconnected, it has increased demands on politicians and regulators. More open capital markets have also increased the incentives for governments to lower tax rates and reduce regulation in order to attract flighty capital.
By raising the prospects for emerging economies, globalisation has been fundamental to the success of the global economy in recent decades. Our best estimate is that globalisation itself is responsible for around a third of the pick-up in global growth of per capita incomes over the past 30 years. That boost has entirely come through a more efficient allocation of resources globally, with emerging markets the biggest beneficiaries as investment and knowledge flows spilled over to help make their domestic economies more efficient too. Globalisation has also helped underpin global co-ordination, helping to reduce the risks of conflict and avoiding “beggar thy neighbour” policies, particularly in the wake of the 2008 global financial crisis.
Forthcoming Focus pieces in this series will consider whether we are now facing the end of globalisation, what form that could take, and the potential impact on the global economy.
Nicholas Bloom, Mirko Draca, John Van Reenen (2011) – Trade Induced Technical Change? The Impact of Chinese Imports on Innovation, IT and Productivity. ↑
David Autor, David Dorn, Gordon Hanson (2016) – The China Shock ↑
Michael Pearce, Senior Economist, +1 646 934 6378, email@example.com