Globalization seems to be hitting a few roadbloacks worldwide. Brexit, then Trump, and now a referendum in Italy and an election in Austria that are taking the form of a vote about further “federalisation” of EU member states. Even weak victories could add cracks in the project and stress global markets.
For good or bad, populations of sovereign countries around the world are more and more skeptical of the “global market and community” and Italy and Austria are next in line, after the earthquakes that brought the downfall of Clinton and pro-EU politicians in the UK.
The signals of these developments along with specific economic, financial, and political conditions in many countries are all putting increased pressure on the EU, and 2017 may well be a very decisive and “dramatic” year for the state of the world and the EU as we know it. Read on to see clearly through the haze.
Globalization, Technology, and Inequality
In a nutshell, globalization is the concept of the free movement of people, ideas, goods, services, and capital around the world, between countries and markets. This implies free trade, “multiculturalism” due to massive flows of immigrants across borders, and 100% free movement of financial capital. Please bare with me for a few paragraphs and read on. You will see where all this is going.
The gains from free trade come from the power of “comparitive advantage” and diversification. Each “player” in this setup concentrates on producing the goods and services he is better at and then exchanging with others who do the same, which brings higher production per person, on average. In the same vain, global capital flocks to the places where returns are higher, which generates growth in poorer countries along with gains from trade in rich countries.
Countries get access to commodities, goods, and services that would be hard (costly) or impossible to get by producing everything themselves, as well as bigger markets, scale effects, more choice, and efficiency, which all help productivity and material standards of living in the long run.
This process brings massive and fast technology-and-knowledge transfer from high-production-capacity countries to those areas that have lagged in their capacity to produce goods and services. Indeed, this has worked: the massive offshoring of multinationals has transferred vast amounts of technology and knowledge within one generation: production organization and technology, management, engineering, distribution and transport networks, and machine usage and design.
This has allowed many countries such as China, India, Indonesia, Malaysia, Mexico, Chile, and Brazil to move up the production value chain at an incredible pace, and has allowed them to produce everything from clothes and electronics to cars and planes, and indeed reduced global poverty at an unprecedented pace, faster than any “development aid” program could ever do.
The issue seems to be that the “gains from globalization” have distributional effects that are seldom discussed in academic or political circles, but are actually very important to most people. As I discussed at length in my post on “Inequality and the End of Jobs,” the issue is that any routine task is replaced by one of two things: cheap labor from Asia or Latin America or machines that do things faster and better, without asking for a break or vacation. This makes any worker that is not “special” highly exposed to global competition of cheap labor and to automation.
The non-routine jobs that are hard to automate or move offshore such as haircuts, house cleaning, or your preferred mechanic and plumber are indeed less exposed, but those displaced by globalization and technology also want to do those same jobs, which of course creates a glut in the lower-end of the jobs food chain: not everyone could be a car mechanic or a hairdresser! While high-knowledge and specialized skills are in high demand, they are not in volumes nearly enough to absorb the masses, so you get rising wages in the upper-level jobs and stagnating wages everywhere else.
In theory, the jobs that are eliminated simply create new markets, because all this allows firms to produce the same value or more value per hour of work at lower cost, thus increasing profits and investment returns. Plus, the remaining workers produce more value per hour, which pumps up productivity and wages, which adds extra purchasing power to the economy… and finally, all this global competition pushes down prices, which of course increases purchasing power of wages and capital income...
We thus have technology, automation, and globalization increasing profits and wages and pushing down prices. This means extra purchasing power… and the extra purchasing power then generates extra niches to be filled by new products, which creates business opportunities and jobs, and the whole thing goes round and round.
Continuing with our little theory, the jobs that the economy no longer needs are eventually replaced by new jobs that are created from this continual process. It looks something like this:
This is the process of economic development in a nutshell. It typically starts with the agricultural sector. The combine harvester replaced millions of workers in the fields by a few workers using the high-output combine harvester. Manual carrot pickers get replaced by the high-output carrot machine, and so on. The process moves up the production value chain, increasing automation and machine precision ever more, and increasing our capaicity to produce (in volumes and in types of goods). This process works. It is what explains our diversified economies and our high material standards of living today. But…
The Modern Reality of Globalization and Technology
Although the process has worked with some imperfections, as exposed by economists such as Brad Delong and many others, allow me to tell you an inconvenient truth: if you live in a rich country, you are probably overpaid. Yes, you read that right, and it fully includes myself. There are very smart and knowledgeable people “out there” who are willing and able to do your job for a fraction of your wage.
In theory, the higher productivity of rich countries makes production costs go down and quality go up, which means that unit labor costs can be competitive relative to lower-income countries: you produce 10 widgets per hour and you are paid 10$/h, so the widget has a unit cost of 1$ of labor per unit… and the poor country worker outputs only 1 widgets per hour and is paid 1$/h, which gives the same unit labor cost of 1$, so you are “competitive” in the global market. That’s the theory.
Globalization and Technology in Practice
Inflation has indeed been reduced globally, mostly due to the disinflationary policies of central banks since the 1980s, but wage and cost pressure also decreased due to global competition and “the China Effect” that puts downward pressure on wages and prices.
The distributional effects of globalization and technology can be grasped by looking at wage data. Here is the reality of wages in the Euro Area:
Here is the impact on the USA, which tells us that real household income in the USA is at the same place now as 20 years ago, which is actually also the case for Europe:
Where does this leave us? First, we have zero improvement of purchasing power for much of the population, while the gains from technology accrue in a disproportionate way to the top 10% through scale effects and high-level human capital, creating the well-documented phenomenon of increasing income and wealth inequality. The problem is that, by definition, the majority can’t be in the top 10%, so they feel left out and frustrated more than ever before. The other problem is that all that top-level income that is increasing lands straight in capital markets and housing, thus pumping up prices and making it harder for most people to access these markets, which further exacerbates the insider-outsider effect, as exposed by many graphs…
What items have had condiderable increases in prices in the past 20 years? Real housing prices are currently at least double what they were 20 years ago in the USA as exposed by this excellent reality check from The Economist, and have increased almost as much in the EU, while the real cost of college and university education has exploded in the USA.
Political, business, and academic elites try to tame the frustrations of the masses by telling them that the stagnation of real wages is a normal “price to pay” for the benefits of globalization, and that they get cheaper washers, dryers, cars, laptops, and TVs, which “compensates” for higher prices in housing, education, and capital markets… but all this sounds very hollow to the masses that are priced out of most markets by global capital, machines, and cheap labor.
The rich pay for good education for their kids and have the contacts to allow them to reap the benefits of globalization… the masses stay on the back seat and just try to get by with a stagnating wage and rising prices of things that make a big difference in the lives of ordinary people. This is hardly a society of “equality of chance” and although slashing the corporate tax rate by Trump (a policy I fully endorse) might get some reshoring, I remain doubtful of the aggregate effect it can have unless it truly is massive and creates a huge incentive to produce in the USA.
Trump, Brexit, and… Italy’s referendum: cracks in the foundations and seeds of frustration!
The masses have had enough of economic models, theory, and discussions about benefits “on average.” The distributional aspects of globalization are important. The masses have had enough of political and business elites getting all the benefits of globalization while they face impossible prices on housing and education, along with stagnating wages and job prospects. They can’t express it like this, but that is what has been happening with Trump and Brexit, and it also shows up in employment rates in many major economies, especially in the USA:
Now Italy and Austria are voting on aspects that are akin to a “vote of confidence” on the project of the “United States of Europe” and further EU integration and “federalisation” of the member states. Although wages are also stagnating in Germany, at least the German labor market is doing relatively well. What about the other big players of the EU?
Well, the four big players are Germany, France, Italy, and Spain. Of these, only Germany is doing well in terms of labor market conditions. The other three are stuck with high unemployment rates, low employment rates, high government debt, and no hope in sight. The fustration is growing and the frustrated are getting inspiration from Brexit and Trump. The votes in Italy and Austria could be additional cracks in the EU project that could pave the way to a very tumultuous 2017 for the EU and the world.
I will not go into the details of Italy’s referendum, but here is the short story: Italian Prime Minister Matteo Renzi is calling for a major overhaul of the political structure of Italy and is putting his job on the line. He wants to shorten and simplify the law-passing process and facilitate faster EU integration. He is a pro-EU politician and a “no vote” would force him to resign, thus opening the door to anti-EU political parties that are pushing for a no vote. This would then embolden anti-EU movements in France, Spain, Greece, and even Germany and pave the way for 2017. Essentially the same story comes out of Austria, but for different reasons. The stakes are very high.
Multiculturalism and global population flows
Ideally, the gains from globalization in poorer countries would allow them to accelarate the pace of catch-up in terms of material standards of living. This is indeed happening on a global scale and at an unprecedented pace, but still the process is “not fast enough” and masses of migrants from poorer countries flock to rich countries to seek a better life.
This adds to the explosive mix. The unemployed of rich countries, made fragile by globalization and technology, do not want hoards of “strangers” coming into their countries – it’s hard enough as it is to make ends meet and to find a job, you don’t want to compete with “those immigrants!”
This strains the communities with extra ethnic tensions. You always get significantly more racial tensions in periods of inequality and stagnation for the masses, simply because people become more protectionnist of domestic job markets. Call them a bunch of uneducated and closed “deplorables” if you want, tell them that they are richer than 95% of the global population if you want, tell them that they are materially better off than 99.9% of the population in History… it all sounds hollow and meaningless to them, and I fully understand them.
People want a fighting chance, a job, and peace. If you confront them with masses of immigrants and replace them with technology and offshore cheap labor, while they are priced out of the housing and capital markets while being forced to pile on mountains of debt for education and health care, eventually you should expect some pushback, and that is what we are getting now – it is all quite “natural”.
Countries that don’t have a close border with low-income countries are somewhat “lucky” and have the luxury to play the role of the “good guys” in this global picture, because they don’t have to deal with hoards of immigrants passing the border. This is the case of Canada, but even those countries have significant challenges about immigrant unemployment, because immigrants often lack the skills and language to quickly integrate, and they are at higher risk of unemployment than the domestic population, as can be seen by the ratio of immigrant unemployment rates to domestic population unemployment:
The broken EU and Euro projects
The USA is a federation of states. Canada is a federation of provinces. Many federations work very well. They allow enough decentralized power for local identities and preferences to express themselves, while providing the power and security of a Union.
For such “federal projects” to work, you need a few general conditions, namely at least some common cultural underpinnings and language, inter-state transfers via a central government to equalize chances and opportunities so that those who are lagging can upgrade and catch up, you need an integrated tax system and unemployment system so that risk can be spread over the entire federation, and ideally a federal bond market. You benefit greatly from labor mobility because the unemployed can move to places where they find jobs without constraints. There are many other criteria, and the EU has very little of them.
EU countries have very distinct histories, cultures, languages, political frameworks, tax policies, and economies. “Federating” these countries requires a transfer of power from the member countries to EU authorities, who are not really elected by the people. The process lacks legitimacy. Populations don’t identify with this great EU Federation, which explains why even the countries with solid labor markets still have significant portions of the population opposing any further “federating” into the bigger block that is the EU.
EU banking problems
As is well explained in a good article by Lucrezia Reichlin and Shanin Vallee, the Italian banking sector is under tremendous pressure:
“the sector runs on a level of profitability that is, on average, lower than its cost of equity and maintains a stock of non-performing loans and hard-to-value assets large enough to undermine its capitalization for years to come.”
The issue now is that bank bailouts have become politically very unpopular and further government interventions to save banks from bad performing loans and under capitalization may add to popular unrest, even if that is what needs to be done to avoid a total meltdown.
Banking sector weaknesses are widespread across the EU as explained in this good piece from Bloomberg’s Alastair Marsh, and this only tells us that Europe is FAR from being done with stagnation and the frustration of the masses.
These banking problems only add to the other issues previously exposed and bring us to one conclusion: the EU is a spark away from catching fire. That spark could come from Italy, Austria, or further down the road in 2017.
Globalization and technology have made ordinary workers exposed to increasing economic risk due to automation and the global labor market. Priced out of important markets such as housing, education, and capital, the masses seem to have had enough and are sending a message that all this “global shit” has gone far enough, along with immigration.
The developments in Italy, Austria, or others in 2017 could put significant pressure for change about a unified Europe, and that is probably the single biggest risk to the global economy going forward. Not counting that forex and stock markets could be rattled quite a bit by these massive shifting tectonic plates in the global economy. Like , share, and comment!