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March 1, 2010

THE WORLD IS NOT FLAT

Forward reviews books on business, economics and trade.

The world is round, not flat. Marco Polo knew that and, it seems, where global trade is concerned, what went around has come around. Yes, technology and high speed this and that have made our similarities easier to see and exploit, but it still takes as long as it takes to get freight from here to there. The high seas are still a perilous place filled with storms and pirates and political shoals. Global trade does not raise all boats; sometimes it swamps them.

The principal lesson from reading recent books about trade is discovering how much things have not changed. We have to keep learning the same lessons that the 2nd century trader riding atop his bales of silk could have taught us: trade only works when it benefits both parties. The amount of goods and money may be bigger, but the principles remain the same.

By William J. Bernstein,
Atlantic Monthly Press, 2008

A Splendid Exchange: How Trade Shaped the World

The financial theorist and author of three other excellent books, William J. Bernstein sets out to prove two theories in this sweeping, 465-page history of trade. First, Adam Smith was right that man has an intrinsic “propensity to truck, barter and exchange one thing for another.” Second, trade has shaped our history as profoundly as politics, war, religion or geography. Trade, in fact, is a huge triumph over geography. Today we take apples from New Zealand and TVs from Taiwan for granted. In the days of the Silk Road, the trader bought and sold goods on his own account and traveled with them every risk-filled step of the way. The life was “slow, perilous, grim, gritty.”

Bernstein writes vividly, taking us from life aboard a ship with 150 oarsmen and no hygiene to the Battle in Seattle at the 1999 meeting of the World Trade Organization. Metal, by the way, makes its appearance on the first page of the first chapter. In about 3000 B.C., herders attacked farmers in the Tigris-Euphrates valley but found that their skull-crushing maces were ineffective because the farmers were wearing shiny orange helmets. Copper had made its way hundreds of miles across the Sinai. The herders got their own copper, made their own helmets and their own metal maces and the first arms race began.

It’s interesting to look at the Crusades, World Wars, the plague, anti-Semitism, among other socio-political events through the lens of trade. Bernstein makes the connection obvious and draws some worthwhile conclusions from the 5,000-year span he covers.

  1. Maritime transport is and has always been cheaper than land, and the three maritime choke points remain unchanged: the Suez Canal, the Straits of Hormuz and Bab el-Mandeb in what is now Yemen. The Middle East was the cradle of civilization and has played a major role in trade since man figured out how to sell things at a profit. Today, according to the book, half of the world’s commercial tonnage is made up of petroleum, which has to come through those same choke points. Trade has made them wealthy but has not made them safer.
  2. “Enthusiasts of free trade have overestimated its economic benefits,” Bernstein writes. Poor nations catch up with rich nations once they adopt free trade or “stagnate and fall ever further behind” if they do not. Low-skilled labor suffers from free trade; high-skilled workers benefit. But geography is still destiny. “The larger and more economically diverse a nation, the more self-sufficient it is, and the less important trade becomes.”
  3. Trade makes the world safer. “Life on earth is slowly becoming less violent, mainly owing to the increasing realization that neighbors are more useful alive than dead.” Trading nations are stable—not necessarily democratic, but stable.
  4. Free trade can be saved from protectionism only if national social safety nets expand. If a steelworker in Pennsylvania loses his job to a steelworker in California, he figures that that’s just the way things go. If he loses out to a steelworker in Korea, he’s a lot less forgiving. Nations with the highest ratio of trade to GDP also have the richest social welfare schemes. One reinforces the other. “Stable, wealthy trading nations, if they want to remain that way,” Bernstein writes, “cannot afford to throw to the wolves those whose jobs can be so easily ‘exchanged’ in an increasingly frictionless global economy.”

 

By Ralph E. Gomory and William J. Baumol,
the MIT Press, 2001

Global Trade and Conflicting National Interests

These two learned authors, neither of them a trade theorist, disagree with point two above, and much else in prevailing trade theory. Geography is not the only determiner of destiny. Once you no longer have to live on a ship without hygiene to get your goods to market, it is not simply natural resources or a high literacy rate that make a country more competitive in global trade. What happens instead is that two trading partners exist in either a “zone of mutual gain” or a “zone of mutual conflict.” In the former, the richer of the two would actually benefit from losing some income share in order to enrich the other and thereby create a better market for its goods. In the latter, the interests of one country are “far from the best” for the other. Western Europe, for instance, where income levels are as good as or higher than in the United States, is in our zone of conflict—it does us no good to give up market share to them. Developing countries, on the other hand, are in the zone of mutual gain. If we were to act in our enlightened self-interest, we could create new markets and better trading partners for American-made goods.

If we were as smart as Gomory and Baumol—and few of us are—we would know which zone we are in with our trading partners and take steps to improve our position. This is not what happens, of course. Even countries that have industrial policies generally do a bad job of it. Instead, countries should focus on basic research, which has benefited the United States even as politics scuttle the dubiously beneficial hopes of an industrial policy.

This is not a book you’ll read in bed. You need to have your shoes on, your wits about you and your highlighter handy. It is meaty rather than obfuscating, thought provoking rather than head scratching. Did we erode our manufacturing base by trying to turn developing countries into better trade markets? The authors would argue yes, that companies acting in their own self interest gained low-cost labor but, in the process, deprived their host countries of all of the other benefits of domestic production. “An improvement in the productive capability of a trading partner that allows it to compete effectively with a home-country industry, instead of benefiting the public as a whole, may come at the expense of that home country overall.”

The interests of companies and the interests of countries do not always align and, over time, trade will not raise all boats but erode the cumulative national interest.

This is not something you will have read elsewhere. This is heresy, in fact, for most economists and certainly for free traders. But coming from a former IBM executive and the former head of four trade associations, it’s convincingly argued.

 

By Pankaj Ghemawat,
Harvard Business School Press, 2007

Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter

Looked at another way, there is no such thing as globalization; national interest is all. The world is not flat. It is just as curved as it was 700 years ago when Marco Polo inspired explorers and traders to see what was beyond the horizon. That, at least, is the belief of Pankaj Ghemawat, professor of global strategy at IESE Business School in Barcelona. Ghemawat has published a string of scholarly works in the Harvard Business Review over the last decade on the research that culminates in this book. He, like Ralph Gomory, is a heretic. The world economy is not frictionless but semi-globalized and our differences still matter.

This is not, strictly speaking, a book about trade. It is at the opposite end of history, where trade ends and globalization takes over. Once you can make Coca-Cola anywhere, there is no need to trade the stuff. Global production enables companies to think and act locally. As former Coke CEO Douglas N. Daft said, “No one drinks globally. Local people get thirsty and go to their retailer and buy a locally made Coke.” However, as Coke found, you can go too far in flattening out the world. There is no such thing as a nation-less company.

Ghemawat outlines his CAGE theory, the four parameters on which national differences still throw up borders that must be crossed by trade, if at all. Of cultural, administrative (political), geographic and economic distance, the one that matters most to metals companies and other exploiters of natural resources is the political. He then draws the AAA triangle (adaptation, aggregation and arbitrage) for global value creation. If you’re thinking of exporting or adding global production, Ghemawat gives you a roadmap with lots of practical advice.

This book is the antithesis of simple. Rather, the author takes the professorial route that tells you what he’s going to tell you, tells you and then tells you what he told you. I haven’t had much patience with that since I was an undergrad. If it were possible to read just the middle—the part where he tells you—it would be fine, but being beaten over the head to ensure that you’ve gotten the point is, well, like being beaten over the head.

It is interesting to know that although the world occasionally undergoes periods of intense integration where we all seem to come together in a long daisy chain (“I’d like to teach the world to sing in perfect harmony…”), we shrink back within our domestic borders with more than a little chauvinism and wait for the traders to arrive. As economic models go, the “simple gravity model” of trade is still remarkably accurate. Trade “between two countries will be directly related to their economic size…and inversely related to the physical distance between them.” We may not use the oarsmen anymore, but distance and size are all that really matter in trade, now as then.

The full-circle direction in which we are headed means that as the countries we traded with became as powerful as we are, they not only needed us and our fizzy drinks less, they also became impatient with our brand of globalization. Instead, they are now able to beat us at our own game (witness Lakshmi Mittal) and are inventing their own version of what world trade will look like.