Drawing on findings in the 2017 OECD Business and Finance Outlook, this article by Adrian Blundell-Wignall looks at some of the forces influencing recent economic developments and asks what can be done to ensure a “fairer” global economy.
30/05/2017 – The first concern of all citizens is to try to ensure that the environment they live in is the best that it can be. Today the debate rages about whether the decline in living standards is due to the effects of globalisation or simply to poor domestic policy. Both have played a role, but even if all countries implemented sound domestic policies, there would still be major losers in a world without a level economic playing field. The size and cost of the policies needed to protect the losers would be burdensome and possibly beyond reach.
With respect to globalisation, the basic problem is that not all countries are “open” to the same extent and the economic playing field is not level. This year’s OECD Business and Finance Outlook discusses many aspects of the lopsided nature of the world economy: capital account and exchange rate management; uneven financial regulations; the growing role of state-owned enterprises (SOEs); cross-border cartels which ensure that the benefits of globalisation accrue to companies and their shareholders instead of to consumers via lower prices; collusive behaviour in investment bank underwriting practices; cutting corners in responsible business conduct; and the bribery and corruption which distorts international investment and misallocates resources.
So what does the data from thousands of companies presented in the 2017 OECD Business and Finance Outlook show us about how uneven global competition is contributing to the backlash against globalisation?
Spectacular developments in trade and international investment – Since entering WTO in 2001, China has quickly become the largest exporting nation in the world, with 14% of merchandise exports and 18% of manufacturing. Hong Kong (China), Singapore and Korea together export as much as the United States or Germany (see figure). Instead of exporting from home, companies can also set up production abroad closer to foreign markets. China is now responsible for 11% of world M&A outflows in 2016 while inward M&A has declined to a low of 2% of the global total.
Why state-owned enterprises may be a cause for concern – There is nothing wrong with success in cross border activities—provided of course that success is not based on unfair competition. SOEs don’t fit the model of managers acting on behalf of diverse shareholders. They are agents of the state and an important part of its industrial strategy. Emerging-economy SOEs are not limited to natural monopolies such as utilities. Indeed, listed companies have heavy state ownership across all sectors— averaging 23% of their market capitalisation. This excludes the vast unlisted SOE sectors. In China, the average market cap of state-held shares is over 40% of the total.
These SOEs have become a force to be reckoned with. The number of SOEs amongst the Fortune Global 500 companies grew from 9.8% in 2005 to 22.8% in 2014. The largest of these are Chinese banks that play an important role in funding state-owned firms in all industries, subsidising the cost of capital and facilitating state-driven industrial strategies. Emerging market SOEs have greatly contributed to the current excess capacity in key materials, energy and industrial sectors. This is contributing to a decline in the average return on equity in many sectors and countries.
Capital account and exchange rate management – The level of the playing field is also affected by capital account and exchange rate management of emerging economies. Advanced economies generally have overvalued real exchange rates—even after allowing for a country’s level of economic development (see figure). Some large emerging economies also price to market to ensure they obtain and maintain large global market shares. This requires variable mark-up in pricing, particularly when exchange rates are permitted to move.
Not all advanced economy companies are sitting still – Penetration of markets by emerging economies evokes responses from companies to move further up the value chain and the leaps in productive potential can be enormous. Companies that innovate well in their own industry quickly find that they run out of room at home. If they don’t take advantage of global economies of scale they will find themselves facing strong competition from other successful firms at home. The fastest productivity growth companies are also those that take advantage of foreign sales—whether by exporting or by setting up subsidiaries that produce abroad to serve foreign markets. It does not matter where firms sit in the value chain. Maquiladoras are just as likely to face global competition as any advanced-economy company, forcing them too to restructure and enhance technology to remain competitive.
Trade versus technology – All of this requires investment, innovation and new technology. The company data shows that it makes no sense to try to separate these things out: to argue that “it’s not trade, it’s the robots” that are hollowing out the middle classes. The companies at the forefront of innovation and technology (as reflected in productivity growth) are often multinationals engaged in trade and foreign direct investment—they buy and sell business segments, set up to produce abroad and the export from multiple global production bases. And yes, they have the resources to invest in R&D or to buy the start-ups that fit with their strategies as they fight it out in the global market place.
Painful wage convergence and the hollowing out effect – The losers in this story (those workers affected by reduced hours, innovative work contracts and compressed remuneration) belong to companies that are scattered within their own industry (it’s not workers of one industry versus those of another). It is not the middle class as such that is being hollowed out—rather, these ranks are swelled by those that work for middle-paying companies that are forced to restructure or exit. Wages in incumbent “once were great” firms are being compressed painfully towards the leaner global adapters as their productivity falls.
Towards greater fairness – Some large emerging economies have managed to pull millions of people out of poverty—and the long-term future of every country lies with continued success in this regard. Competition too is to be welcomed. Like any sporting match, let the best teams win. But also like any sporting match, the game needs to be played with the same rulebook. If the same rules do not apply to all, then fairness is put into question. If fairness is questioned, then sustainability of open trade and investment in the global economy is also put at risk.
The 2017 OECD Business and Finance Outlook tries to look at a number of the elements of what a level playing field might look like. It offers instruments and guidelines that could be used to improve the rules of the game and enhance international co-operation. This requires a commitment by economies participating in globalised markets to a common set of transparent principles that are consistent with mutually-beneficial competition, trade and international investment across a range of areas.