Globalization and International Locational Competition, Lecture by Anne O. Krueger, First Deputy Managing Director, IMF
IMF News, May 11, 2006
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- Published: May 11, 2006
Overview
- Lecture delivered at the Kiel Institute, May 11, 2006.
- Main thesis: long-term reductions in trade and transaction costs have expanded the tradable share of output and intensified locational competition; as transport and transactions costs decline, domestic policy and institutional factors increasingly determine where firms locate.
Drivers of falling trade and transaction costs
- Transport technology and costs
- Ocean freight rates fell by 70 per cent between 1840 and 1910.
- By 1850 ocean shipping costs were about a third of what they had been thirty years earlier.
- O'Rourke and Williamson data: US–Europe transport costs fell from about 80 percent of the price of the commodity to less than 20 percent during the second half of the 19th century.
- In 1947 transport costs were about 25 percent of the value of exports on average.
- Containerization example: loading loose cargo in 1956 cost $5.83 per ton; first container ship reduced loading cost to less than 16 cents a ton.
- Air freight: in 1965, 6 percent of US imports and 8 percent of exports by value were carried by air; within three decades those figures rose to 22 percent and 29 percent respectively.
- Cost of air freighting goods as a proportion of value fell by almost 3.5 percent a year between 1973 and 1993.
- Communications and transactions
- Telegraph and telephone reduced transactions costs in the late 19th and early 20th centuries.
- Constant 1998 price example: a three minute phone call New York–London cost $293 in 1931 and around $1 in 2001; in 2006 that call costs just a few cents.
- Internet and telecommunications further lowered financial and information costs, facilitating geographically dispersed production and services offshoring.
- Trade policy liberalization
- In 1947 average tariffs on manufactures in the industrial countries were over 40 percent.
- By the late 1990s average tariffs among industrial countries had been lowered to less than 5 percent.
- Transport costs in 1947 (about 25 percent) were smaller than tariff costs (over 40 percent), so tariff reductions were highly significant for postwar trade expansion.
Trade growth and structural change
- Historical growth rates and magnitudes
- World trade grew on average by 3.4 percent a year between 1870 and 1914.
- World trade volume in 2000 was 22 times higher than in 1950 (WTO estimate).
- Merchandise exports have grown by an average of 6 percent a year for the past fifty years.
- World trade rose from 10 percent of world GDP in 1960 to almost triple that level in 2005.
- Trade in services is now more than one quarter of trade in goods.
- Value chain and component trade
- OECD parts and components exports rose roughly fivefold between 1978 and 1995 (Alexander Yeats).
- US parent company exports to foreign affiliates for further processing rose from 8.5% of total U.S. exports of goods in 1966 to 14.7% in 1999 (Borga and Zeile).
- Services offshoring
- McKinsey estimate: offshoring of services to emerging markets will have averaged annual growth of 30 percent between 2003 and 2008, taking offshoring share of total services trade from 3 per cent to 10 percent.
- 2003 figures: Irish offshore services exports around $8.5 billion; Indian offshore services exports in excess of $12 billion.
New determinants of locational competition (domestic policy and institutions)
- Declining relative importance of distance and transport increases weight of domestic policy variables:
- Macroeconomic stability (inflation): developing country inflation averaged 80 percent in the 1990s; in the last 5 years the average rate has been only 6 percent; IMF projects a further fall in developing country inflation, to 5 percent next year.
- Institutional and legal framework: independent judiciary, property rights, enforceable contracts, anti-corruption efforts.
- Domestic infrastructure and regulatory environment: costs of domestic transport and communications; red tape; labor market regulation; sophistication of domestic financial systems.
- Empirical and illustrative indicators (World Bank Doing Business 2006 examples)
- Starting a business:
- Germany: 9 procedures, 24 days.
- Venezuela: 13 procedures, 116 days.
- Mozambique: 14 procedures, 153 days.
- Enforcing contracts:
- Germany: 26 procedures, 175 days, cost about 10 percent of the debt.
- Denmark: 15 procedures, 83 days, cost about 5 percent of the debt.
- Guatemala: 37 procedures, 1459 days.
- Italy: 1390 days.
- Labor market dismissal costs (cost to employer measured in weeks of salary):
- New Zealand: no cost to employer in laying someone off.
- United States: no cost to employer in laying someone off.
- Germany: 67 weeks of salary.
- Ecuador: 131 weeks of salary.
- Sierra Leone: 188 weeks of salary.
- Evidence of reform and competitive dynamics
- Doing Business 2006 identified 25 countries that during 2004 improved credit information sharing.
- 31 countries eased business entry in 2004.
- Germany was the top reformer in 2004 in the field of labor market regulation.
- As some countries improve policies, competitive pressure increases on those falling behind.
Policy implications and recommendations
- Trade liberalization
- Continued multilateral liberalization can further reduce trade costs: tariff reductions, improved market access, reduction or elimination of export subsidies.
- Significant opportunities exist in agriculture and services liberalization; many developing countries could lower tariffs on manufactures and industrial countries could reduce tariff peaks on manufactures.
- Doha Round prospects:
- A successful Doha agreement could provide a boost to world trade and global growth, with developing countries gaining most.
- World Bank estimate: around two thirds of all the gains from a good Doha agreement would go to developing countries; gains could run into hundreds of billions of dollars over a ten year period.
- Failure of Doha would weaken the global trading system, encourage protectionism, slow global growth, and reduce resilience to shocks.
- Domestic policy priorities for attracting economic activity
- Pursue macroeconomic stability (low and declining inflation).
- Establish sound institutional and legal frameworks: enforceable contracts, property rights, independent judiciary, anti-corruption measures.
- Improve business environment: reduce red tape, lower costs and duration to start a business, enhance contract enforcement efficiency.
- Reform labor market regulations to reduce hiring and firing costs where excessively burdensome.
- Develop domestic transport, communications, and financial infrastructure; improve credit information systems.
Conclusion and key takeaways
- Long-term declines in transport costs, transaction costs, and trade barriers have drastically expanded tradability and integrated the world economy, contributing to unprecedented trade and output growth and large reductions in global poverty.
- As trade and transport costs shrink, domestic policy, institutions, and regulatory environments play an increasingly decisive role in locational competition.
- To capture the benefits of globalization, countries need both continued trade liberalization (notably via a successful Doha outcome) and sustained domestic reforms to macroeconomic policy, institutions, and business regulation.
- Globalization is not a zero-sum game: with appropriate policies, all countries can benefit.
Lecture delivered by Anne O. Krueger, First Deputy Managing Director, International Monetary Fund, at the Kiel Institute, May 11, 2006.