Globalization of Production
Traditional trade theory, associated with David Ricardo, is based on the idea of comparative advantage. During its heyday, this theory described trade relations in ways that are simple by today’s standards. Less developed countries, on the periphery of the world economy, would supply raw materials to the core countries, who, in turn, would supply manufactured products to the peripheral countries. Ricardo, who helped develop the labor theory of value, later taken up by Marx, argued finished products have more value than the raw materials they consist of, because of the human labor added, thus adding value. In terms of trade, this gave the advantage to developed countries who would gain greater benefits from trade. In today’s economy, not only is outsourcing, and intra-industry trade important factors, but as Eric Thun shows, the idea of global production chains is more adequate to explaining the complex relations of production that exist, thus Ricardo’s views of trade seem outdated today.What is the evidence for globalization of production? Thun, citing the UN, points to high levels of foreign direct investment (FDI), increasing from $59 billion in 1982 to $17 trillion by 2008. These flows are quite concentrated in a small number of hands, and they are mostly directed from developed countries to developing countries.The globalization of production is driven by transnational corporations, TNCs, who seek to reap the benefits of “economies of scale,” or benefits that result from large scale production (reducing costs, increasing output), by seeking markets for goods, sources of raw materials, and now centers of manufacturing in developing countries. While all nations may have a comparative advantage in something, business firms, on the other hand pursue their own “competitive advantage.” FDI is one way firms pursue this advantage, but not all outsourcing (relocating a task from one firm to another) requires FDI. Outsourcing goes back to the earliest period of the world economy in the 15th century, but since the 1990s, is increasingly a feature of discourse on trade. The basic motivation for outsourcing is to lower the costs of labor, by finding low-wage labor in developing countries, like China or Mexico. TNCs can either set up their own facilities, requiring FDI, or as is common with firms like Apple, find sub-contractors, like Foxconn, that will oversee production. Many Apple products carry the label “Designed by Apple Made in China.” This speaks to the globalization of production, and division of labor this entails: developed countries supply the capital and “intellectual property” while developing countries handle the actual manufacturing. Also keep in mind, Foxconn is actually a Taiwanese company with facilities in China. So, in this case, an American company contracts a Taiwanese manufacturer, with a factory in China that hires Chinese laborers, to assemble products that will be sold in American stores. That is a simple model of how global production works.
However, trade is even more complex than that and consists of high levels of intra-industry trade, or trade in similar sectors of the economy. Ricardo’s model of trade highlights the relations between developed and developing countries (core and periphery), but intra-industry trade goes on between developed economies as well, in similar industries. In Ricardo’s theory, countries should focus on their comparative advantage and specialize in different areas of production, instead there is tremendous overlapping production between countries. If China is the paradigm, or model, example of trade between developed and developing countries, then Japan and Germany can be seen as models for explaining intra-industry trade, especially the auto industry. Again, according to Ricardo’s theory of trade it is easy to explain why the US would import raw materials like rubber and steel to manufacture cars, but does not explain why competition exists between manufacturers in different countries. Nevertheless, anyone can see that foreign car manufacturers have a large presence in the US (reflected in “market share” or the percentage of the overall car market they make up). One factor, of course, is cost, many cars are cheaper (although of same or better quality) than American made cars. However, as more recent economists acknowledge, qualitative factors do matter, not just over all quality, but design and stylistic choices as well. Generally speaking too, people prefer more choices, so the rise of intra-industry trade is not that hard to explain, although it does complicate how we understand trade globally, again, not fitting the simple pattern of resources flowing from developing countries to developed countries, and finished products going to developing countries.The creation of supply chains is perhaps the most complex aspect of production today, as it breaks apart, or fragments the production process even more. Now, even the idea of outsourcing is antiquated, at least if you assume that outsourcing of production goes on in one centralized location. Today’s products, again like Apple, are manufactured in different locations, who produce component pieces, or modules, which are then assembled together, usually in China, and “imported” by developed countries like the US. It may seem strange to think of it this way, but firms have found this actually lowers the costs of production, although of course this is only possible because of “liberal trade restrictions,” and technology has reached a high level of development.The economist, Robert Reich breaks down what he calls the anatomy of an iPhone, not detailing the production process, but the breakdown in value based on the value added to the production of the phone:Although, assembled in China, and according to trade stats, made in china, and registered as an import from China, you can see that very little of the actual value of the phone is made by China. The most expensive components of the phone are made by Japan, Germany, and South Korea, which are then exported to China, who assembles the phone, the exports it to the US or wherever. As you can tell, the rise of supply chains distorts the whole idea of imports and exports, which again are based on a more simplistic idea of trade. This is even important in trade conflicts with China, as it shows the large trade deficit the US runs with China is exaggerated, since many of the imports from China, actually come from somewhere else, including in many cases US corporations operating in China.
The splitting up of production into global value chains raises issues in how these chains are maintained, or the governance of these chains, as well as issues arising from the location of these chains. The governance of these chains can be secured, Thun argues, through the coordination provided by markets, which will adjust production patterns according to supply and demand; but also through network coordination, or the binding effect of international institutions that allow for deliberation and information sharing, in turn reducing the so-called “transaction costs” between countries; and hierarchical coordination through FDI.Thun questions the conditions under which a firm will invest directly in a foreign country rather than sub-contract. He uses the economist John Dunning’s so-called “eclectic model” to explain this, basically, a firm will invest if it sees the costs of doing so are less than the costs of sub-contracting. Dunning goes on to specify conditions when this occurs. Besides so-called internalization advantages, there are ownership advantages, for example to protect production techniques they do not want to share, or to capture benefits of economies of scale that requires large scale production. There are also location advantages that may be gained through ownership of raw materials, like oil fields or mines, as well as advantages like low taxes.
Gereffi, Humphrey, and Sturgeon analyze the conditions under which different types of supply chains will develop, and which type of coordination will be strongest. Gereffi, and others, focus on three variables: 1) the complexity of inter-firm relations; 2) the degree to which this complexity can be codified, meaning broken down into routines that can be reproduced; and 3) the extent suppliers have the capabilities to meet the requirements of buyers. This leads to types of governance for supply chains, as Thun says:
Market relations will tend to prevail when transactions are not complex, product specifications are easily specified by the buyer, and supplier capabilities can easily meet these demands. A buyer of inexpensive plastic toys, for example, can easily switch from one supplier to another, and a simple contract will suffice. Modular value chains will occur when the interfaces between complex modules can easily be codified, and there are supplier capable of providing the sophisticated modules on either side of the interface. Large auto supply firms or contract manufacturers on the electronic industry are prominent examples. Relational value chains involve complex transactions, product specifications that are not easily codified, and highly capable suppliers. The result is mutual dependence between firms, close relationships that involve the exchange of tacit knowledge and relationships that are regulated through reputation, geographical proximity, and social, ethnic, and/or family ties. In captive value chains both the complexity of transactions and the ability to codify this complexity is high, but the capabilities of suppliers are low. The lead firm in these cases must provide the core design elements of product and significant assistance to the supply firm, and because it does not want other customers to benefit from new supplier capabilities that may result, it seeks to lock the suppliers into a ‘captive’ relationship. By not providing key design elements or complementary activities, for example, the supplier firm will remain dependent on the lead firm. Finally, when product specifications cannot be codified, products are complex, and highly competent suppliers cannot be found, a firm will rely on in-house capabilities and hierarchical coordination (pp. 291-92).
Market relations would involve little to no FDI, while hierarchical coordination is the most direct usage of FDI, along with captive value chains, with the others falling in between. Apple’s production process would be a good example of a modular supply chain. The Japanese car industry is a good example of a relational value chain as car manufacturers generally use Japanese parts suppliers as well, preferring them to parts makers from other countries.Besides, governance, the geographical location of supply chains matter as well. Remember that in terms of comparative advantage, some countries are labor intensive, meaning they have an advantage in producing goods that require large expenditures of labor. Through trade they will accumulate capital, and move into capital-intensive industries, requiring large expenditures of capital. This brings added conflict with other capital intensive countries, but what happens to the supply of labor intensive production, since there is still demand for those products? This is the basis of the so-called “flying geese” model which shows that as labor intensive countries become capital intensive, other countries will copy this approach. This has been compared to a formation of flying geese, where the leader directs the movements of the followers. Seeking to exploit their own comparative advantage, labor intensive countries will copy the policies and strategies of countries like Japan. The historian Bruce Cumings describes this process in relation to Japan, Taiwan, and South Korea. Japan passed on its industrial structure to these countries, who begin by importing products from Japan, then slowly develop the ability to produce these things themselves, developing to the point they start exporting to other countries like the US, but also to China, which again begins to mimic the structure of these countries. Atul Kohli and Meredith Woo-Cumings have shown this also stems from Japanese colonization of Taiwan and Korea before World War II, who in large part had the Japanese structure of production forced on them. This shows that supply chains are determined by historical forces as much as geography, and the cost benefits of maintaining these chains.Of course it is China more than any other country that has become the factory of the world. China compared to other East Asian states is the late developer. Japan by the early 20th century had become industrialized, re-building itself after World War II, while by the 1960s already people began taking notice of Taiwan and, at least, South Korea. China’s industrialization (the largest and fastest in history) has only been ongoing since the 1980s, not counting the disastrous attempts at industrialization under Mao Zedong, although scholars dispute if it may have laid a foundation. As many have noted, China’s record shattering growth has dramatically impacted the environment through global warming, as China, and India, and other developing countries consume more fossil fuels with increasing industry. The political and economic consequences are also great as China becomes a capital intensive country, competing with high tech industries in the US and Europe, it is also seen now as a rising power in the eyes of many, who past experience would say disrupts the balance of power between states. China’s current leader Xi Jinping, as mentioned, has displayed a more authoritarian stance not seen in the prior administration. The social consequences are almost too great to imagine, as hundreds of millions of people, in a country with almost 1.4 billion people, have been lifted out of poverty, also resulting in the greatest internal migration in history as millions have moved from the rural country to urban areas, jam-packing Chinese cities to a degree that is unimaginable in the US. At the same time, the advances in communication have been felt in China as well, with a large underground media that tries to stay ahead of the censoring authorities. China besides industrialization is undergoing its “modernization” which as Marshall Berman argued is the melting down of traditional social forms into a new mixture. China under Mao also underwent the “Cultural Revolution” a very strange and violent episode in China’s recent history so it is no stranger to the notion that “all that is solid melts into air.”Of course besides China, India is also the big story of development over the last several decades, not seeing significant growth until the 1990s, and to to the same extent as China. Robyn Meredith in the book The Elephant and the Dragon, highlights the paths of development taken by both countries, and is a good introduction to both.
Singapore, another “Asian tiger”
The globalization of production shows no signs of slowing down, even after the recession. It does create interdependence between the world which is important to remember, even as other pressures seem to push the US and China into a collision course. The challenges brought by it are manifold and there is no reason to think that people are up for the challenge, least of all the environmental challenges, let alone the social, political, and economic consequences. That only deals with countries that have actually been successful at attracting FDI, or otherwise building themselves into an industrialized economy. Many regions of the world like sub-Saharan Africa have been unable to attract FDI, while many countries in Latin America, have not been able to exploit the benefits of FDI for indigenous firms, as capital flows back to developed countries. Within developed countries too, the benefits of global trade and investment, have, again, been highly skewed, leading to extreme inequality, in turn fueling a backlash against globalization.
