Economic Globalization


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What is Economic Globalization? 

Information Courtesy Congressional Research Service, IF11016

In general, economic globalization broadly refers to the increasing integration of national economies around the world, particularly through trade and financial flows. Economic globalization involves trade in goods and services, capital flows and trade in assets (e.g., currency, stocks), the transfer of technology and ideas, and international flows of labor or migration. There have been several periods of economic globalization; some experts also contend there have been periods of deglobalization—the slowdown or reverse of globalization.

Scholars have dated the start of the most recent period of economic globalization to sometime in decades following World War II. From 1960 to 2019, global trade as a percentage of global GDP increased from 25% to 60%. In the post-World War II period, global trade grew consistently faster than GDP (though this trend has not held in recent years). The stock of global foreign direct investment (FDI) grew from 6% of global GDP in 1980 to 42% in 2019. The growing integration of the world economy has been facilitated by myriad technical advances in transport and communication, which have significantly reduced natural geographic barriers that separate economies. In addition, both domestic and multilateral policies have steadily lowered man-made barriers to international exchange since World War II (such as tariffs, quotas, subsidies, immigration regulations, and capital controls). While most economists argue that globalization has lifted living standards worldwide, an ongoing debate remains regarding the extent to which greater economic integration has been inclusive, benefited some groups more than others, and contributed to inequality within countries. 

What are global value chains and how do they relate to globalization?

Global value chains (GVCs) disaggregate production processes into discrete stages in various locations around the globe to achieve efficient production, allowing companies to organize different parts of their value chain strategically, such as locating in a target customer’s home market or a competitor’s base. Since the 1990s, powered by trade liberalization through free trade agreements (FTAs) and the creation of the World Trade Organization (WTO) and advances in services and technology, companies have increasingly structured international trade around global value chains. More than two-thirds of world trade occurs via GVCs each year, representing a shift in how trade and commerce are conducted as trade in intermediate goods and services exceeds that of commodities and finished goods. This shift makes it increasingly difficult to understand and interpret the implications of trade data trends for the U.S. economy as conventional trade data do not attribute any portion of the traded value of finished manufactured and agricultural products to intermediate goods or services.

Despite the growing presence of GVCs in the global economy, recent events have highlighted the potential risks and vulnerabilities of GVCs, particularly those concentrated in a particular region or reliant on a single supplier. Worldwide natural disasters, emergencies, and other policy-driven circumstances, such as the Coronavirus Disease 2019 (COVID-19) pandemic, have shown that GVC links integrate and create interdependence between economies, which can leave companies vulnerable to external shocks, including interruptions in other countries. At the same time, inter- dependence can create broader economic growth and strengthened relationships among nations.

Although using GVCs can offer significant benefits, doing so can create additional costs and raise risks. To mitigate risks and vulnerabilities, companies may (1) rethink their business models and seek to build in redundancies for resilience, (2) focus more on shorter local or regional value chains, and/or (3) utilize emerging technologies to lower and diversify risks and costs. These shifts will likely vary across industry sectors, depending in part on the location and availability of suppliers and customers, as well as U.S. and foreign trade and investment policies.

What is the relationship between trade and foreign direct investment?

Trade and investment flows are complements, and foreign direct investment (FDI) is considered to be a major driver of trade. FDI is a type of cross-border capital flow, which takes place when a resident of one country (including a company) obtains a lasting interest in—and a degree of influence over—the management of a business enterprise in another country. FDI has supported the development of global value chains by multinational corporations (MNCs), which source production globally. As a result, the majority of trade takes place within MNCs that send components to and from locations at home and abroad to transform into final products. FDI has thus supported the significant expansion of inter- and intra-firm trade, which represents trade between parent companies and their foreign affiliates, and trade between affiliates of foreign firms and the foreign parent company (see “Link Between International Investment and Trade”).

A predominant reason U.S. firms make investments abroad is to sell goods and services to foreign markets. Many firms want to maintain operations close to their customers to gauge preferences and tastes that may differ from U.S. consumers (e.g., SUVs preferred in the United States versus small cars in Japan). According to the latest data on activities of U.S. multinationals, in 2018, 12% of the sales of U.S. foreign affiliates went to U.S. parent companies, while 58% of sales went to the local market of the host country and 30% went to other foreign countries. However, some firms may also establish operations abroad to replace exports or production, or to gain access to raw materials or less expensive labor abroad. Foreign firms may invest in the United States to access the U.S. consumer market, high-skilled labor, and other resources.

How does globalization affect jobs?

Greater global integration through trade and investment flows, combined with specialization in certain stages of production, can disrupt markets. This disruption may create concerns about “offshoring” or “outsourcing,” the shift of manufacturing and business functions to countries with lower labor costs. For example, some U.S. multinational corporations (MNCs) focus on high-end activities associated with innovating products in the United States, such as research and development (R&D), while outsourcing production of components and final product assembly to suppliers and locations abroad. Although most economists maintain that globalization and trade liberalization are unlikely to affect the overall U.S. employment rate, greater volatility of U.S. worker incomes and employment in some sectors are possible effects. For example, the shifting of manufacturing assembly abroad may reduce the number of U.S. manufacturing jobs in some industries but boost the number of service-related jobs in others.

Another issue is the impact of globalization on wealth distribution; for example, through dampening wages for U.S. lower-skilled workers facing greater foreign competition compared to higher-skilled workers, or through higher returns to capital over labor. In one study, the OECD concluded that “in advanced economies, at least 10% of the decline of the labour share [in total national income] is accounted for by increasing globalisation—and in particular by the pressures from the delocalisation of some parts of the production chain as well as from import competition from firms producing in countries with low labour cost.” A range of studies suggests that within the United States, globalization has contributed marginally to rising U.S. wage inequality at a factor ranging from 10% to 20%.