The World Ain't Flat

I agree with Brad Setser, the World Ain't so Flat, but Tom Friedman gets all the buzz, partly because "The World is Flat" is a best-seller:

"A world where one major economy consumes something like 70% of its income and another something like 40% of its income is not very flat. And we should not forget that there remains an enormous chasm between per capital income in China (roughly $1,500 at market exchange rates) and per capita income in the US ($40,000). We may be headed for a flat world, but we are not there yet ... "

One of Wall Streets most senior Economic strategists, Morgan Stanley's Stephen Roach doesn't buy it either. If you read carefully, Roach is critical of a world where all the consumption is in the US, and all the manufacturing is in the East: he does not believe this is sustainable. How can Friedman ignore the asymmetry that exists in the World Economy?

"I give Friedman a lot of 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.

... 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 stuff 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 America’s consumption share held near a record 71%. With 35-40% of Chinese exports going directly to the US, 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 US-centric external demand than internal consumption. India’s consumption-led growth dynamic is encouraging, but with per capita spending of only about US$400 per year, the global impact remains trivial at this point in time.

... Over the past five years, industrial world labor markets have suffered from both jobless and now wageless recoveries. The US, 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, as I have dubbed it, 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 (i.e., manufacturing), and nontradables (i.e., 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 but they also have 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 nontradables 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.

... As I speak with businesspeople, 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 they have no plan as to how to repair the damage. "