What is Globalization?
Globalization is the process of separate economies around the world becoming more intricately connected, creating and selling products across national borders.
You have probably heard about globalization in the context of outsourcing (jobs moving overseas), but globalization has a broader meaning. It is the process of different economies around the world becoming more interdependent. In the past, you might have seen wheat grown, turned into flour, baked into bread, and traded to a neighbor for cheese. In the modern world, it is more common to see the wheat grown in one country, shipped to a mill in another country, sold as flour to yet another, and ultimately sold to someone living on another continent altogether. This use of factors of production from around the world forms a much more connected economic system. The process of becoming connected is called globalization.
Auto manufacturing is a prime example of globalization. In the early 20th century, a car might have been manufactured with virtually its entire supply chain in one country, from metal mining to assembly to the final sale to the consumer. Today, it is common for an automobile corporation to have its ownership in one country, its manufacturing in another country, its raw materials from several continents, and its final consumers all over the world.
Globalization is like moving from a small town to the big city…
In a small town, there may have been fewer jobs, fewer available goods and services, and a less diverse assortment of neighbors. In the big city, you may feel less security, but there are more opportunities to work, experience novel things, and meet new people. Similarly, the less globalized economy of the 20th century may have felt more secure to some people, but globalization in the 21st century has opened up a tremendous engine of economic progress and innovation — though not without risks.
Globalization is the process of integration between places. For simplicity, it can be thought of as international trade. While a lot of factors have contributed to increased globalization, two primary factors have led to a rapid increase in connectivity around the globe.
First is transportation — The ability to move people and products around the world brings places closer together. In the modern era of air cargo, seafood can reach the plate in a restaurant thousands of miles away on the same day it was caught. Produce grown in the other hemisphere makes seasonal fruits and vegetables available year round. And the containerization of marine, rail, and road transportation systems connect communities in a way that allows things manufactured anywhere in the world to find their way to your local retailer.
Second is communication — In the age of constant contact, there is no distance separating our ability to speak with one another. We all have a cell phone within arms reach, most of which have a connection to the internet. This incredible advancement in communication means that we can place and receive orders, manage our workforce, check on project progress, and deal with disruptions in real-time and from anywhere.
These two factors have made the world a much smaller place and have connected economies in profound ways.
While the word “globalization” became popularized in the 1970s, the process of integrating continental economies can be traced back to a few key innovations going back centuries. Author and New York Times columnist Thomas Friedman pegs the beginning of the process to the transatlantic crossing of 1491. Some historians argue that global trade can be traced back much further. But the period of empire building and colonization during the 16th and 17th centuries was certainly a step in the direction of globalization.
Still, the industrial revolution marks the beginning of the connected world we live in today. Steam-powered railroads and ships dramatically increased the ability to move goods. Meanwhile, the steam engine jump-started the massive increase in the manufacturing of things to transport. Likewise, the telegram began the process of decreasing the time between sending and receiving information around the world.
Beginning in the early 1900s, the personal automobile began changing the mobility of labor, allowing people to move or commute to where the jobs were. The telephone improved communication even further. And then manned aircraft took flight. Between the civil war and the first world war, technology propelled the global economy into new territory and shifted the average household from the farm to the city.
The first half of the 20th century was mired in global conflict. Most of the innovation that drove globalization was expended in the pursuit of moving armies and designing weapons. From those military efforts came advances in transportation, communication, medicine, and energy that revolutionized everything a population does. And, with the continental U.S. being shielded from the destruction of war, its manufacturing industry led the world.
Since the 1990s, globalization advanced much more quickly with the advancement of information technology, the growth of multinational corporations, and the increase of international trade agreements. The internet networked international business operations. The flow of information across oceans in real-time improved coordination across borders and allowed employees to work further from company headquarters. Having a corporate presence in several countries also broke down the idea of single-nation ownership. Multinational corporations expanded their reach and brought global leaders to the same table.
As the flow of commodities (raw materials), intermediate goods (parts used to make final products), and consumer products moved more steadily between business units, the sense of protectionism waned, and many outdated trade barriers were torn down. This effort resulted in the North American Free Trade Agreement (NAFTA) in 1994, the European Economic Area in 1994, and the creations of the World Trade Organization (WTO) founded in 1995. Other trade agreements, including one between the United States and Europe, have been under negotiation ever since.
In the 21st century, advances in transportation have driven down the cost of shipping products around the world. Shipping costs are so low that it is often cheaper to pay someone in China to build things, plus the cost of shipping, than it is to pay Americans to build the same thing.
This process of jobs moving to countries with cheaper labor is called outsourcing. One effect of globalization is that many businesses seek the lowest cost of production, regardless of where in the world it is found. Consequently, low-skilled labor in developed countries competes with similarly skilled labor in developing countries with a population willing to work for far less money. The result has been lower wages or a loss of employment opportunities for many Americans; meanwhile, the same forces have lifted millions of people around the world out of poverty.
The lower cost of production has also led to lower costs for consumers, more access to consumer goods, and more profits for many business owners. Globalization creates a larger market for businesses around the world, aligns the financial interests of countries, and often lets each country specialize in what they do best. Plus, when countries benefit from trade, they are less likely to fight wars against each other.
Like anything, there are pros and cons related to globalization. And, like most things, there are winners and losers. Therefore, the topic can be very controversial and politically charged. But, here are some of the general advantages and disadvantages of globalization:
In the modern free market economy, everything a business does tends to reach across national boundaries. Customers can live anywhere in the world, place an order on the internet, and receive your product from thousands of miles away in just a few days. If your business makes a physical product, you can source materials from one continent, manufacture it on another, and sell it on another – All from your home office in yet another continent altogether.
Globalization has changed what it means to run a business. Information is much easier to find, driving up competition and pushing down prices. Work can be done remotely, changing the way we go to our jobs and making it possible to export services as well as goods. Customers can find a business without walking into a shop. And transportation systems pull everything together in a networked global supply chain.
The end result is that business has been dramatically impacted by the interconnectedness of economic systems in a world economy. A company's potential consumer base has gone from a few thousand people living in the immediate area to billions of people around the world. Access to materials and manufacturing from anywhere in the world is just a few clicks away. All of this has led to lower costs, more competition, and better profits for many businesses.
Companies are in the business of making money. To do so, they typically seek the lowest cost way of making a product. Not only do lower costs lead to higher gross margins, they also allow businesses to be more competitive with their pricing to attract a larger market share.
As shipping costs have fallen, the difference in labor costs between manufacturing locations has become more important. For example, if it takes 100 labor hours to assemble a car, you can calculate the labor cost per car by multiplying the average labor cost by 100. If a person in the U.S. has a required wage of $25 per hour, the car has $2,500 of labor associated with assembling it.
If a person in China is willing to do the same work for $5 per hour, the labor cost goes down to $500. As long as the additional expense to ship the car from China is less than $2,000, the company can reduce the cost of making that car by opening a factory in the lower wage area and shipping it.
In this way, globalization has resulted in many manufacturing jobs moving to lower-wage areas of the world. Thus, in this example, the middle-class U.S. workers with higher wages end up losing jobs while impoverished Chinese workers with lower wages gain jobs. The shipping company also ends up adding jobs. The person buying the car ends up paying a little less, allowing them to use that money in another way. Wherever they spend that money, those businesses end up needing more workers to handle the increase in business.
There is not a fixed number of jobs in the world, and globalization is not a zero-sum game. Everything is connected. When some jobs are lost, often, others are created — even if it’s not an equal number of jobs to those that were lost. While that does cause some structural unemployment, there are usually offsetting gains that result in economic growth. How you weigh those positive and negative impacts will generally depend on if you are a person that lost your job or if you are a person that benefits from the situation.
A trade deficit is the difference between the value of the things a country exports versus imports. In a closed economy, the people that live in a region would make everything they need. All trade would happen within the economy. But maybe something you want cannot be created where you live. In a closed economy, a person living in New York would never taste a pineapple.
Trade allows people to access things they do not have by giving up things they do have. As a result, both people are typically better off, and they can focus their efforts on their comparative advantage. Comparing the value of the things sold to the value of the things bought would give you the trade balance.
If you simply trade money for goods produced elsewhere, there is no value of exports to offset the value of the imports. Therefore, you would have a trade deficit. In other words, you receive goods without selling any (outside your country’s borders).
Globalization has significantly increased the volume of trade. Consequently, trade balances have grown over the last few decades. Places with a lot of money, like the United States and European Union, tend to purchase goods created elsewhere for cheaper without exporting as many products as they buy.
Thus, the U.S. has had an increasing trade deficit for many years. That does not imply that the U.S. owes products to these other countries. It just means that Americans have purchased more things from other parts of the world than other countries have purchased from American businesses during the year.
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