The Economics Of Globalization

Globalization isn't a new phenomenon. The growth of worldwide networks of interdependence is almost as old as human existence. During the last thirty years, the importance and reach of these networks has advanced rapidly, taking many inward looking people by surprise.

As globalization has evolved, so has its definition(s). The one used here comes from Financial Times chief economic commentator Martin Wolf:

Globalization is defined as integration of economic activities, via markets. The driving forces are technological and policy changes--falling cost of transport and communications and greater reliance on market forces.

In its current form, globalization has grown mainly because of money funneled by mature economies to developing ones. As the latest United Nations World Investment Report states:

At $648 billion, world foreign direct investments (FDI) inflows were 2 percent higher in 2004 than in 2003. Inflows to developing countries surged by 40 percent, to $233 billion, but developed countries as a group experienced a 14 percent drop in their inward FDI. As a result, the share of developing countries in world FDI inflows was 36 percent, the highest level since 1997.In the case of the United States, outflows increased by over 90 percent, to $229 billion, a record high.

Those figures demonstrate that the world economy has reached a different level of interconnectivity than in the past. This has been facilitated by the mobility of capital and the developing countries' work toward providing the infrastructure for receiving and properly using these funds.

Previously, investments in developing economies targeted simple manufacturing and other low-end production activities. Now, however, more parts of a corporation's functions are up for grabs. The old unwritten rule that the high-end "untreatable" functions, such as research and development (R&D), are reserved for workers of the company's home country is fading away.

This shift has had two main effects: the gradual redistribution of income from developed to developing economies and a shift from growth- to income-oriented policies for developed economies. There are additional consequences, most notably higher resource prices, but these are the result of income redistribution and higher demand.

As things stand now, the only way globalization could slow down is through regional social unrest and protectionism. The latter has never worked, usually producing hardships, instability, and unfavorable economic environments. As a result, societies have been adversely affected, thus, leading to more problems.

The bottom line is that no one ever knows how politicians will decide to deal with constituency pressure. As Samuel Brittan noted, "Every unwise move in American economic policy has been rationalized by the protectionist fear, just as every unwise move in foreign policy has been rationalized by the fear of isolationism."

A Dangerous World

The global geopolitical picture isn't bright. The US continues to be involved in a complicated situation in Iraq where the outcome is anybody's guess; few observers are currently in a position to assess the consequences for the area and the world.

Furthermore, Iran's latest actions regarding its nuclear capabilities and the transfer of substantial amounts of its foreign exchange reserves from Europe-based banks to ones in Asia have unnerved many policy makers. At this point, you can't seriously dismiss a potential confrontation between Iran, the US and its closest allies.

The situation is becoming more complex because the US is trying to gain a foothold in Central Asia--which is traditionally under Russia's, and to a lesser degree China's, influence--about which Moscow and Beijing are upset. Hence, astute observers aren't surprised by Iran's purchase, from Russia, of Tor-M1 defense systems, to be delivered in 2006, worth more than $1 billion. China's support for Iran has also been clearly conveyed to European Union (EU) and US representatives.

Russia and China don't necessarily want to see Iran armed with nuclear weapons, yet the two countries seem to be using the situation as a countermeasure to what they believe is a threatening hegemonic attitude by the US.

North Korea remains an uncertain spot on the political world map. That's in part because six party talks haven't proved successful, with Russia, China and South Korea adopting a different position than their more hard-line partners, the US and Japan.

As an aside, the changes in Latin America's political map (e.g., socialist-oriented governments being elected) and the deteriorating situation in most of Africa are not small developments. Yet, the situations in the Middle East and Asia appear to be more pressing.

One of the world's most important geo-strategic puzzles is the future of the Sino-Japanese relationship. The issue has multiple dimensions, including China's rise as an important economic and political power, the future of Taiwan and Japan's efforts to have a significant presence in the global political arena. To do so, Japan is focusing on increasing its defense capabilities to shed its post-World War II geopolitical eunuch status.

The US' status as the sole superpower, its involvement in a number of the world's hotpots, such as the Middle East, and its role in guaranteeing stability in East Asia during the past sixty years makes the Sino-Japanese relationship's evolution even more relevant to investors. If correctly positioned and patient, you have the opportunity for outstanding profits.

China's and India's economic growth during the past decade has been the focus of every investor for the past three years. (Note: India's rising geo-strategic status will be the theme of an upcoming report.) As these economies grow stronger, so does their need for a better defense and power projection capabilities. Add to this the needs of a former imperial power (i.e., Japan) that boasts the second biggest economy in the world, and you can appreciate the magnitude of the change that will take place in the not-so-distant future.

Asia's rearmament has already started and will continue for years to come. Its consequences will be far reaching and change the global balance of power forever.

© 2006 Yiannis G. Mostrous
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