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The Hollowing Ring of Davos

Will the internet help the developing world economically eclipse the developed countries?

January 31, 2006

Will the internet help the developing world economically eclipse the developed countries?

The World Economic Forum is the cradle of the modern-day globalization debate. The motto of the organization says it all: “Committed to Improving the State of the World.”

The win-win endorsement of globalization — that the development of poor countries is a huge plus for rich, developed countries — was first coined in Davos.

Alternatively, there have been anti-globalization protests associated with this event for years.

But this year is different. The debate has moved from the outside to the inside. Serious challenges to globalization are now being openly aired in the rooms and corridors of Davos’s fabled Congress Centre.

The reasons behind this shift are not hard to fathom. One of the "wins" in the win-win of globalization has failed to materialize.

Job creation and real wages in the mature, industrialized economies have seriously lagged historical norms. It is now commonplace for recoveries in the developed world to be either jobless, or wageless — or both.

That this shortfall has occurred in the midst of accelerating globalization and surging global trade is all the more disconcerting.

It was one thing for this to happen to the structurally-impaired economies of Europe and Japan. But now it is occurring in the world’s most flexible economy — the United States.

Gains in U.S. worker compensation — by far, the biggest component of overall personal income — have lagged while productivity growth has soared.

This slow wage growth is at odds with one of the basic premises of economics, which maintains that labor is always paid in accordance with its productivity contribution.

Yet, the facts say otherwise: Over the first 48 months of the present economic expansion, private-sector compensation in the United States has increased only 12% in inflation-adjusted terms.

By contrast, over comparable periods of the past four business cycles, gains in private compensation averaged 20% in real terms.

The Davos crowd was stunned by this turn of events. A recent spate of high-profile layoff announcements in the global car industry only added to the grim realization.

Of course, a hollowing out of the manufacturing sector is nothing new for the industrial world — it has been going on for over 30 years.

But in a year when the World Economic Forum is celebrating the emergence of China and India, the impacts of the global labor arbitrage hit home as never before.

After all, if India is to services as China is to manufacturing, what does the future hold for high-wage workers in the rich, industrial world?

The toughest part of this story is that there may be no easy way out. That’s because there is an important new wrinkle in the equation — the most disruptive technology in the history of the modern world.

The Internet has changed the rules of engagement for globalization. It has revolutionized the logistics of supply chain management, accelerating the diffusion of global manufacturing platforms.

But perhaps, even more importantly, e-based connectivity has introduced the possibility of offshore outsourcing and wage compression in once non-tradable services industries.

Five years ago, the globalization of the information function was confined to call centers and data processing.

Courtesy of the Internet, those pressures have migrated quickly to the upper end of the value chain, bearing down on workers in software programming, engineering, design and the medical profession.

Equally affected is a broad array of professionals in the legal, accounting, actuarial, consulting and financial services industries.

The speed of this transformation, to say nothing of its capacity to blur the distinction between non-tradables and tradables, turns the win-win models of globalization inside out.

And it puts knots in the stomachs of most free-market economists, including myself. For generations, we harbored the belief that while it was painful, it was also understandable for rich countries to lose market share in tradable manufacturing activities.

This was never viewed as a serious threat because the developed world was blessed with a growing profusion of highly-educated knowledge workers toiling in non-tradable services — workers that were effectively sheltered from the tough pressures of global competition.

It was win-win because rich countries would be able to buy cheaper things from poor countries, thereby expanding the purchasing power of an increasingly knowledge-based workforce.

And as producers in the developing world turn into consumers, a proliferation of new markets would provide nothing but opportunity for the industrial world. This positive-sum outcome was the true hope of globalization.

Those hopes have now been dashed. The old fears of the zero-sum outcome have crept back into the discussions at Davos.

Gains in the developing world are increasingly feared to come at the expense of the developed world.

This has taken the world to the brink of a very slippery slope — the blame game. Middle-class workers and their political representatives are up in arms.

The pressures bearing down on a productivity-led U.S. economy are the final straw for the body politic. Witness the outbreak of China bashing in the U.S. Congress.

Yet, protectionism may not be the real risk in all this. I do not believe that the world would be so foolish to repeat the tragic mistakes of the 20th century.

The more likely danger is that the powerful countries in the industrial world now view the Chinas and Indias of the developing world with a growing sense of distrust — more as economic adversaries than as strategic partners.

A world of distrust may well squander the greatest opportunities of globalization.

Like it or not, IT-enabled globalization has unexpectedly tilted the playing field. Labor markets in the industrial world have an increasingly hollow ring. And so did this year’s debate at Davos.

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