(This essay was published in Hong Kong Economic Journal on 6 September 2017.)


Global Supply Chains and Hyper-globalization

Since 1990, hyper-globalization has gripped the world, but we are only beginning to understand it. Hyper-globalization is different from the old globalization that prevailed from 1820 to 1990 because it is happening at a much faster speed. It has also resulted in a much higher degree of global economic integration requiring extensive institutional adaptation in the societies it has impacted.

And whereas the old globalization was driven primarily by declining transportation costs, the new hyper-globalization is driven by the revolution in information and communication technology, according to Richard Baldwin’s 2016 path-breaking study entitled The Great Convergence.

The share of world GDP of the most advanced major economies in the world (the G7 comprising Canada, France, Germany, Italy, Japan, the UK and the US) rose from 22% in 1820, to 46% in 1900, and reached 67% in 1993, but fell back to 46% by 2014.

It took the G7 economies 93 years to increase its share from 46% to 67%, but only 21 years to amazingly lose it all due to hyper-globalization.

The share of world manufacturing in the G7 economies declined from 65 per cent in 1990 to 47 percent in 2010. The decline was made up for by only six countries – China, South Korea, India, Poland, Indonesia and Thailand. China’s manufacturing share alone increased from 3 percent in 1990 to an amazing 19 percent in 2010.

Explaining the rapid reversal of the share of world output of the G7 economies and the rapid rise of a small number of emerging economies is the subject of Baldwin’s thesis. If you want to understand Hong Kong’s economic situation today and that of the rest of the world, but only have time to read one book, this should be your choice.

The appearance of global supply chains plays a central role in Baldwin’s thesis of hyper-globalization. Global supply chains may be producer driven (for example, Apple) or purchaser driven (for example, Wal-Mart, Zara, Li & Fung, Amazon, Alibaba).

Prior to 1990, globalization was mostly about trade in finalized products with manufacturing production clustered in the rich industrialized economies. After 1990, global trading activity, in particular regional trade, became increasingly dominated by trade in intermediate goods.

This meant manufacturing production was no longer clustered in the advanced industrialized economies. Manufacturing production could be off-shored, geographically dispersed and fragmented by global supply chains that were on a very large scale hitherto unseen prior to 1990.

Impact on New Emerging Economies

This arrangement made it feasible for the developing economies to industrialize rapidly and become emerging economies. By joining global supply chains, they received a transfer of manufacturing know-how from companies in the advanced industrialized economies. And they could scale up their operations to a global scale in specific niches in the supply chains with only limited know-how.

Global supply chains enabled the emerging economies to industrialize even faster than the “four little Asian dragons” that followed the old “flying geese” pattern of the old globalization, in which export-oriented industrialization had required total know-how in manufacturing a final product.

Baldwin reasons that hyper-globalization has worked because the revolution in information and communication technology makes it possible for headquarters to retain effective control of offshore production operations. In essence, factories can now be shipped out, foreign workers effectively managed, and only limited knowledge needs to be transferred to foreign economies. Headquarters are more willing to transfer niche know-how to offshore operations rather than total know-how to foreign operations.

This contrasts with the old globalization where only final goods were shipped out to foreign economies. Shipping out goods meant taking lesser risks than shipping out factories. Companies with offshore production operations are not only concerned about tariff and non-tariff barriers at the border, but a host of other issues including taxation and business regulation, intellectual property rights, labor laws, transparency of government policies, competition policies, capital repatriation, foreign exchange control, dispute resolution mechanisms, and more.

To join the old global supply chain, developing economies had to first improve their business investment environment in order to attract foreign investments in offshore operations. In the hyper-globalization era, emerging economies have to become much more deeply integrated into the global economy, not merely at the customs border of the old globalization.

These developments led to growing recognition that, the General Agreement and Trade and Tariffs framework was inadequate and obsolete, leading to its replacement by the broader framework of the World Trade Organization and regional ones like the North American Free Trade Arrangement, the Trans-Pacific Partnership, and the Transatlantic Trade and Investment Partnership

China’s Rise

Under hyper-globalization, proximity and familiarity have played a role in deciding where to locate offshore production operations. Offshore manufacturing operations are concentrated in only a few developing economies – those familiar and in close proximity to the investors from rich industrialized nations, and willing to open and reform their economies to become business-friendly. Thus Germany has favored Poland, the US has favored Mexico and Pacific Asia, and Japan has favored Pacific Asia.

Deng Xiao Ping’s decision to open and reform China’s economy in late 1979 ahead of all the other developing economies was timed perfectly. China’s state machinery was commanded to make room for markets to develop. Businessmen and professionals from free market Hong Kong became the ideal tutors to show China how to build the most friendly business environment in a socialist economy for attracting foreign investments.

As a consequence, China became deeply integrated into the global economy on a scale totally unimagined at the time of its opening in 1979. Hyper-globalization might have been enabled by the information and communication technology described by Baldwin. But its blossoming came about due to Deng’s initiative and Hong Kong’s responsiveness.

As a first-mover, China has benefited enormously from joining the world’s global supply chains before most other economies did. The abundant supply of Chinese workers transformed coastal China into the world’s dominant offshore manufacturing base for companies in the rich industrialized economies.

Hyper-globalization is largely a story of China’s re-emergence, or “The Great Convergence” in Baldwin’s characterization. As an economist, I am delighted to have witnessed this from the front-row and take enormous pride in seeing how the people and institutions of Hong Kong have helped to make the new economic history of the 21st century.

Hong Kong’s Growth Challenge

Under hyper-globalization, companies in the rich industrialized nations that offshored production to low cost developing economies have scaled up, sold more output because production costs are lower, and invested in more innovation to further boost productivity. Their demand for knowledge-intensive jobs, especially in research and development and marketing, has increased as output and sales volumes have risen. But some factory jobs have been lost.

This is not a straightforward case of the “hollowing out” of industry. These companies and industries have expanded but with a different mix of employees. Labor’s GDP share has fallen, but the rewards to knowledge workers have increased. The result has been very disruptive in the G7 economies and also in Hong Kong. And it has happened very quickly.

The old globalization benefitted almost everyone in companies that sold goods abroad. But this has not been the case since production began being offshored after 1990. This has sowed the seeds for divisiveness. Hyper-globalization is not just Reagan’s “shining city upon a hill,” but also rust belt towns with long-shuttered shops, abandoned factories, and homes where families scrape by with part-time low wage jobs.

In many rich nations, these woes have led to a backlash against globalization. The global financial crisis of 2008 and the subsequent recession and slow recovery have made matters worse. The U.S. produced Trump and in the U.K. it resulted in Brexit.

Hong Kong has fared much better than any of the G7 economies. The massive migration of manufacturing operations across the border was accomplished without producing unemployment thanks to a flexible labor market and a rugged “can-do” spirit. But like the other economies, Hong Kong is suffering from a shortage of knowledge intensive workers and an abundance of lesser skilled workers, a situation made worse by inward migration flows.

Although some manufacturers have continued to innovate, invest in research and development, and make great strides, very often the only functions that remain in Hong Kong are marketing and sales. Many have worried about the lack of innovation in Hong Kong and the dearth of new knowledge intensive industries. China, especially in Shenzhen, has done very well in building up its manufacturing and innovation base.

In the new era, disruption comes from all directions and there can be no escape. Protectionism is doomed to failure because it hurts more than it helps. In the era of hyper-globalization innovation is the only feasible strategy for joining the global supply chain – attack is the only defense.

The main barrier to innovation in Hong Kong is the shortage of knowledge intensive workers. Public investment in higher education ceased to grow after the 1990s. The labor force itself has stopped growing and even declined in most years since the mid-1980s, especially the youth labor force. This is the most formidable challenge. The government has a critical role to play in promoting education. It is imperative that it push ahead in developing new manpower and population polices – a human capital policy.

Another barrier is the ossified and anti-competitive business regulations that have slowed down innovation. Before 1997, the government compensated Hong Kong Telecom and purchased back its franchise to open up the telecommunications market. Nowadays we set up barriers to entry, stifle innovation, and make it hard for innovators to do business in Hong Kong.

Bureaucrats are far too keen on protecting the status quo and avoiding risks. They are more likely to throw the rulebook at business and enterprise in fear of disruption, rather than finding enabling solutions to conquer the new world. Our former departments of industry and trade worked strenuously to support the garment and textile manufacturers to rise to the top of the global supply chain after the US Commerce Department slapped the Multi-Fiber Trade Agreement on the world. Today bureaucrats wring their hands in “no-can-do-ma!”

Finally, in an era of information and communication technology, access to big data is the lifeblood and source of the rise of many new startups. Consider the transformation and modernization of our real estate agency business that created Centaline and Midland, which would not have been conceivable without government making public real estate transactions records in digital form.

The government and its statutory bodies sit on tons of data that are off limits to the public but that could become transformational for many industries and old and new companies. If the government took the lead to open up its data banks and considered a fresh approach to compensating some of our industry incumbents so they would not stand in the way of progress, then competitive markets could re-emerge in our highly promising service economy.

Today visitors from the Mainland scoff at the backwardness of our financial technology. In so many areas, regulatory barriers have held back innovation and competition, and reduced job opportunities for our young people. It is ironic that although Hong Kong businesses and professionals helped the Mainland to build a business friendly environment, we have failed to keep improving our own environment and often erected obstacles to progress.

China’s economic rise, the spending power of its growing middle class, and its continued integration with the global economy presents enormous opportunities for the new generation, both those who are already based here and others that may be attracted to come.

Unshackling the barriers and constraints that hold back the creativity of our people and investing in their human capital will be the two most important policy strategies Mrs. Carrie Lam’s government can do to release the enormous potential of Hong Kong for the 21st century – the shape of which we had a big hand in creating over the past three decades.

The social and economic woes that inflict Hong Kong (and also the other old industrialized economies) are the products of hyper-globalization. They are different from the woes of the old globalization. They need to be understood anew and treated with fundamentally new policy strategies. This will be the subject of my next article in four weeks.

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