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Squaring the Circle of a Flat World

Is the global economy really as flat as Thomas Friedman would have people believe?

November 29, 2005

Is the global economy really as flat as Thomas Friedman would have people believe?

I give Friedman credit for bringing globalization to the masses (see his “The World Is Flat: A Brief History of the Twenty-first Century,” Farrar, Straus and Giroux, 2005). But to me, "flat" just doesn't cut it in today's world.

Yes, IT-enabled connectivity has shrunk the world in many new and important respects. But the world is struggling mightily with what this connectivity has brought. China and India are reshaping the global economy as never before.

The 40% of the world's population that lives in these two countries is only just getting a taste of economic prosperity. Not surprisingly, these two behemoths have big appetites and are pushing ahead rapidly with very different development models.

China has done it the manufacturing way by catering to external demand, while in India it's been more of a services and internal consumption story. The theory of globalization teaches us that this is a "win-win" development.

As the Chinas and Indias enter the global economy, they provide cheap goods, and now services, for the rest of the world. At the same time, they create a new class of consumers who will buy things made in developed countries. Who could ask for more?

My travels tell me that the theory isn't working as advertised. Globalization may well be win-win in the long run, but in the here and now, it is profoundly asymmetrical.

It has given rise to a multitude of new entrants on the supply side of the global equation — but very few new consumers on the demand side.

With the important exception of India, Asia remains very much an external demand story — aiming its rapidly growing production platform at providing import goods for the overly-indulgent American consumer.

Two numbers say it all: In 2004, Chinese consumption fell to a record low of 42% of its GDP, whereas the U.S. consumption share held near a record 71%. With 35-40% of Chinese exports going directly to the United States, there can be no mistaking the dichotomy of the roles played by the rich and the wannabes.

With the rest of Asia now increasingly integrated into a China-centric supply chain, the region remains far more skewed toward U.S.-centric external demand than internal consumption.

India's consumption-led growth dynamic is encouraging, but with per capita spending of only about $400 per year, the global impact remains trivial at this point in time.

But the asymmetries of globalization have an equally profound effect on the other side of the ledger — on workers in the rich, developed world. Over the past five years, industrial world labor markets have suffered from both jobless — and now wage-less — recoveries.

The United States, with the world's most flexible labor market, has been on the leading edge of these trends. While hiring has picked up over the past 24 months, the private sector job count remains more than 10.5 million workers below the profile that would have been generated by a more typical hiring cycle.

Moreover, the inflation-adjusted hourly pay rate is virtually unchanged over the 46 months of this recovery — underscoring the rare confluence of surging productivity growth and stagnant real wages.

At the same time, structural unemployment remains a serious problem elsewhere in the developed world — especially in both Europe and Japan. And make no mistake — workers in the developed world are far from pleased over this outcome and the global context in which it has arisen.

The global labor arbitrage adds a critical new and surprising wrinkle to globalization. The time-honored Ricardian models of comparative advantage have always broken down economies into two broad sectors — tradables (such as manufacturing) and nontradables (such as services).

The theory was that rich high-wage economies would gladly give up market share in manufacturing to low-wage workers in poorer economies in exchange for lower-cost goods.

This exchange would then prompt a migration of vulnerable workers in the rich countries from openly-tradable manufacturing to sheltered, non-tradable services industries.

Economies in the developed world would then thrive as increasingly knowledge-based systems — and the developing world would flourish as a manufacturing center.

Courtesy of the Internet, this model has now broken down. IT-enabled breakthroughs have not only revolutionized the logistics of supply-chain management in manufacturing.

They have also transformed once non-tradable, information-based activities — such as software programming, engineering, design, accounting, lawyers, medical and financial analysis — into tradables.

In an era increasingly dominated by the ultimate disruptive technology, the distinction between tradables and non-tradables has become blurred.

Employment and real wage compression in the developed world is a direct outgrowth of this blurring — and so is the politics of the labor backlash it has spawned.

The hyper-speed of an increasingly asymmetrical globalization is hardly the stuff of a flat world. I haven't come to this critique of globalization casually.

As I speak with business people, government officials, investors and political leaders around the world, I am struck by one thing these seemingly diverse groups all seem to have in common: They recognize the unexpected pitfalls of globalization — but have no plan as to how to repair the damage.

The other day in Beijing, a senior Chinese government official threw up his hands in exasperation when he nearly pleaded with me, asking, "What can China do to reduce the bilateral trade tensions with the United States?"

He then went on to answer his own rhetorical question by expressing frustration over U.S. restrictions against Chinese purchases of high-tech products.

"I guess that means we'll have to buy some more Boeing aircraft," he said literally a couple of days before the news broke of a large order of Chinese jet purchases.

Clearly, the Chinese producer on the supply side and the American consumer on the demand side are the two major engines of the world economy. In a flat world, these two engines would be working together in near perfect harmony.

In today's world, however, they are like passing ships in the night — cruising full speed ahead on their own journeys in increasingly choppy seas. Globalization at this point in time is far more about disparities between nations than the assimilation of a flat world.