Globalisation: What are its causes and consequences?

What is globalisation?

Globalisation is the increasing interdependence of different economies.

For example, world trade as a percentage of GDP has risen from about 10% in 1950 to around 60% in 2011.

Tariff rates have fallen to single digit percentages in most major world economies.

It is now much quicker to communicate with and travel to the other side of the world.

There are more financial flows and migration flows across borders. 

Below, we discuss the causes and consequences of globalisation. Also, is there evidence for so-called “deglobalisation”?

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Contents

What has caused globalisation?

Here are the key factors that have contributed to globalisation:

Technological improvements in communications and IT

Phones, mobile phones, the internet (World Wide Web), social media have all made it easier and cheaper to communicate across borders. This means that it is cheaper to move parts of a firm overseas (offshoring), reducing business costs for firms and leading to greater cross-border supply chain links. It also makes it easier for firms to advertise their products abroad, leading to increased exports.

Technological improvements to travel 

Faster travel by plane, car, train and ship means reduced transport costs for firms, making it cheaper and quicker to export and import items. This includes for example the increased use of containers for shipping, also known as “containerisation”. These larger containers allowed increased volume for goods compared to miscellaneous bags and boxes, and made it much easier to offload goods from a ship. 

Trade liberalisation 

Tariff reduction and trade agreements have reduced costs of importing and increased imports. Tariff reduction also makes it cheaper to export into other countries, increasing exports. But in more recent times, there have been more protectionist policies such as US tariffs on steel or leaving the European Union. Free trade allows countries to exploit their comparative advantages.

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Multinational corporations

 These large cross-border companies spread production around the world to achieve lower labour costs or economies of scale. Ultimately this will increase profits. That leads to greater supply chain links across borders. The multinational companies may also find new markets to increase demand for their products, increasing profits on the revenue side of the equation.

International financial flows

Relaxed capital controls make it easier for money to flow across borders. This leads to higher foreign direct investment, which encourages growth.

What are the consequences of globalisation?

Workers

  • Developing countries:
    • More foreign direct investment in the local area means higher employment. There may also be multiplier effects that generate even higher aggregate demand and even higher employment.
    • Workers may receive more training funded by firms offshoring in that country, raising their levels of human capital, marginal revenue product and pay. 
    • Higher wages possibly in comparison to previous work.
    • Gentrification – improves the quality of buildings and jobs in the area but could force locals out of the area.*
    • Worker exploitation – various clothing companies have been accused of using sweatshops. Such treatment may also harm wages, particularly if these multinational firms exert their market power to force down wages of workers (monopsony power). This could worsen poverty. 
  • Developed countries:
    • Rising inequality is likely. More specifically:
    • Higher demand for more skilled jobs. This could include for example engineering, technology and finance due to increased demand for transport, technology and increased international financial flows. So these workers will have a higher marginal revenue product and hence receive a higher wage.
    • Offshoring means less demand for low skilled workers, as firms may prefer to use low skilled labour from developing economies where wages are lower. This typically applies to primary resource and some manufacturing jobs. For example coal and steel plants or car companies. The UK has seen a relative decline in its share of the global car industry owing in part to increased international competition from among others Japan, the US and mainland Europe.

Firms

On the cost side, firms have cheaper inputs. More international competition and the ability to mine raw materials directly make raw materials cheaper. The fact that firms can offshore factories to countries with lower labour costs or reduced taxes means reduced costs for firms. This means the aggregate supply curve shifts right. But if firms are exposed for reducing costs by exploiting workers with poor wages and conditions, this could harm firms by reducing their revenue and hence sales.

As firms grow in size, particularly multinational firms, they may experience economies of scale, that is their long-run average costs fall as output increases. For example firms may be able to bulk-buy inputs at a per-unit discount. But there could also be diseconomies of scale.

While on the revenue side, firms can access new markets abroad more easily, increasing the demand for their product.

This all means higher profits for firms, which may be reinvested into improving the quality of the product or reducing costs. It may also make the shareholders of the firm better off.

Yet there are some firms that may be worse off as a result of international competition. Local firms in developing economies may be crowded out by multinationals that pay higher wages to their workers; while primary and secondary sector firms in developed economies see reduced demand owing to increased international competitors that can produce the same goods more cheaply.

Consumers

Consumers see a reduction in prices because of reduced tariffs, increased international competition and reduced firm costs from offshoring being passed on to the consumer. A tariff diagram could show the increase in consumer surplus as a result of trade liberalisation. 

With greater competition may come more options. For example fruits that can only be grown in certain countries or at certain times of year. There may also be competition on a quality basis, driving up the quality of goods. However there could be a “race to the bottom” in quality standards as firms compete to reduce costs.

Consumers may care about factors other than just cost. Consumers could protest with a boycott of certain products to push up workers’ wages and working conditions for example. An example of this is the Fairtrade initiative to give a fair price for those who produce coffee beans.

At a macroeconomic level, there may be more imports as a result of the wider choice of consumers. This may improve consumers’ standard of living but may lead to a shift left in aggregate demand, as well as a greater leakage from the circular flow of income. This depends on how self-sufficient the country is as well as its marginal propensity to import.

Government

  • Governments may reduce their corporation tax rates or other tax rates to attract multinational companies. Throughout the last few decades, most OECD countries have seen corporation tax rates decline. 
  • Governments may also lose revenue because of companies relocating or because companies may redirect their profits to low tax areas.
  • But more recently we have seen an agreement signed by 136 countries to have a minimum corporation tax of 15%. In theory, this may mitigate some of the profit shifting.
  • There may be deregulation to encourage businesses, particularly multinationals who may have bargaining power over governments, to use that country for business. This could for example harm workers’ rights. One could argue that bodies such as the United Nations could come up with international agreementsin order to stop this but this may be difficult.
  • When it comes to more advanced economies, higher pay for skilled workers may mean more government revenue. However higher unemployment in primary resource and manufacturing industries, due to offshoring, may mean higher government spending on welfare benefits.

Is there evidence for “deglobalisation”?

Trends in global openness have led some commentators to use the term “deglobalisation” to mean globalisation in reverse.

Even beyond the Covid-19 pandemic, one could argue that the world’s largest economies were looking increasingly inward rather than outward. Consider for example the implementation of trade barriers by the US, China, the EU and the UK as well as energy crises and sanctions.

The Covid-19 pandemic led to a drop in flight passengers because of government restrictions. For example Heathrow passenger numbers dropped 97% in the pandemic relative to the year before. Over 20% of container shipments across the Pacific Ocean were cancelled. 

To some degree this may be short term. As the restrictions are removed, these numbers have recovered but increased restrictions on trade and movement of labour, capital and goods still exist around the world, as well as a desire to move supply chains closer to home.

Other Questions

How does globalisation affect the environment?

Greater use of transportation and shipping, as well as increased industrialisation around the world, are likely to increase emissions of greenhouse gases, harming the environment. Building roads and airports may destroy habitats.

Specialisation under free trade and comparative advantage could lead to overexploitation of resources and lower biodiversity. Deforestation in Brazil may serve as an example of this.

So it is likely that globalisation harms the environment. However improvements in efficiency driven by specialisation may reduce the emissions from production. There may also be increased awareness of harms to the environment because of greater information sharing. Consumers could boycott products that harm the environment more, for example.

Where can I read more about globalisation?

I recommend readings and lectures from Joseph Stiglitz and Dani Rodrik (see for example here) as well as bodies like the International Monetary Fund. Here is an article discussing some of the perceived problems with globalisation.

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Tom Furber

Helping economics students online since 2015. Previously an economist and economics tutor, I now focus on providing economics resources on tfurber.com. Read more about me here.