Since Adam Smith’s seminal 1776 work An Inquiry into the Nature and Causes of the Wealth of Nations, scholars and practitioners have grappled with a central question: Why are some nations rich while others are poor?
While this question is of vital interest to policymakers, businesses, and citizens around the globe, we are far from a consensus. What we do have, amidst this lack of certainty, are persistent yet erroneous answers to some aspects of the grand rich-or-poor question, including the role of globalization in the world economy. But why has the misthinking of globalization remained influential for so long?
Take, for example, the post-1990 model of economic development that turned on offshoring and industrialization. This held that prosperity for developing nations would come by “joining Global Value Chains (GVC)”, and to do that, all they had to do was improve their investment climate, regulatory setting, infrastructure, and trade policy. Embracing these “Washington Consensus” reforms was the ticket-to-ride on the GVC escalator to rapid industrialization. Jumping on the escalator would trigger an expanding industrial base, leading to rapid income growth and economic development. And the GVC-led development plan promised that effects would snowball: more investment would create more good manufacturing jobs locally and bring further technology development and an upskilling of the workforce, which would attract even more foreign investment and knowhow. The ultimate result would be rising living standards, falling inequality, and increased social cohesion and prosperity.
That was the theory. Alas, as the old quip goes, ‘the difference between theory and practice is different in practice than it is in theory.’ The GVC-led development plan worked for a handful of emerging economies which had links, geographical or otherwise, to the then manufacturing giants: the US, Germany, and Japan. China was the standout example of how the plan could work.
Unfortunately, three spanners have jammed up the inner mechanics of GVC-led development. The first spanner was the end of the offshore expansion phase (roughly 1990-2008). During this phase, unprecedented advances in information and communication technology facilitated the organization of complex production processes across international borders. This was the phase of globalization when factories (and associated knowhow) started crossing borders to arbitrage large wage differences. The second was the advent of digital technology (‘digitech’), which automated labor out of manufacturing and thus reduced the incentives for wage-arbitrage-based offshoring from G7 economies. The third is simple: China.
“Other developing nations – that are competing with low-tech and low-wages – have lost out to China’s massive industrial base”
China is now the world’s largest manufacturer, combining fairly high levels of technology with fairly low levels of wages. Other developing nations – that are competing with low-tech and low-wages – have lost out to China’s massive industrial base. There are still G7 pockets of industry that succeed in using a high-tech-high-wage combination to outcompete China, but overall the G7’s share of global manufacturing output has been declining since 1990.
The good news is that a combination of the same forces of digitech and globalization – ‘globotics’ – is opening a new pathway to prosperity for developing nations, namely service-led development.
In fact, the implications for development are potentially transformational. Why? Because, whereas manufacturing capability underpinned the old model of trade-led development, services increasingly appear to be the future for emerging economies.
Since the 1950s, development theory has emphasized the significance of industrialization for economic development. China is the classic example of this industry-led development paradigm. But, where China relied on manufacturing for its growth, India’s was driven by the services sector – a highly atypical growth pattern for a developing country.
It’s easy to understand why governments all over the world still look to the China model of development as a template. Implemented throughout the late 20th and early 21st centuries, a large swathe of the population moved from field to factory, wages grew, livelihoods improved, and political stability was the order of the day. Hundreds of millions of citizens were lifted out of poverty, a strong middle class arose, and China attained superpower status. But the China development pathway, for so long a model for other developing nations, is less accessible to those that follow – which means we should stop according it the status of absolute truth.
International competition is key here. It’s hard for developing nations today to get into manufacturing because manufacturers in East Asia, Central Europe, and Mexico are already so far ahead – and in any case, the low-hanging fruit in offshoring has already been picked.
Now ‘reshoring’ manufacturing is the dominant trend, characterized by the simplification of global supply chains, both within and between nations.
Stormy seas are looming on the horizon for the goods trade. The international rules-based trading system and the broad (if sometimes reluctant) tolerance of the free-trade model is fracturing. Conflict between major powers, populist sentiment, and concern about climate change are spurring moves and countermoves by regulators, tax authorities, and national budget-holders. The waters are growing rough for international investment, making once-intrepid sailors cling to friendly shores.
Just as digitech is helping make the China pathway to development obsolete, it is helping usher in another pathway by making remote workers less remote – a key factor since they are so much cheaper. Through more robust telecommunications, constantly improving collaboration platforms, and radically improved machine translation, digitech has enabled the rise of internet platforms that do for international trade in services what eBay and Alibaba did for international trade in goods.
The ability to browse, engage, task, remotely manage, and securely pay service providers on the other side of the world, who enjoy vastly lower costs of living – $5 an hour is a middle-class living in most countries in the world – is facilitating international price arbitrage in the services sector in the form of service-sector offshoring.
This is sparking significant change in the business-to-business (B2B) space and inside individual firms as they cut costs by purchasing their services abroad and by outsourcing or relocating their internal business processes overseas.
“The Philippines also offers potential lessons because, unlike India, its rise as a services-exporting hub was at least partly driven by deliberate government strategy”
The key takeaway here is that frameworks that give foreign actors the reassurance that their data will remain secure will become key points of differentiation among the service-export hubs of the future.
Much as development theory focused on industrialization throughout much of the 20th and early 21st centuries, the international rules-based trading system fixated on trade in goods and was largely silent on trade in services. To an extent, the trade in services benefited from this benign neglect, and it seems reasonable to say that international rules have played a muted role in the growth of globotics-driven services exports to date.
So, how can an international rules-based trading system, and trade policy more generally, help power (or at least not impede) globotics-fueled development?
If the shift to a more service-led development path is driven by factors independent of international trade rules, and without significant new protections, perhaps the best thing the multilateral system can do is nothing: greater scrutiny from governments, even if trying to help by creating supportive rules, may do more harm than good.
The shift toward digitally enabled service exports has to date occurred in loosely regulated intermediate services or liberalized sectors, but there is no guarantee that these services will remain unregulated if G7 nations react in knee-jerk fashion if previously sheltered jobs start heading overseas. Restrictions on data flows, privacy, the hiring of freelancers, and other measures could throw spanners into the machinery of business process outsourcing, damaging the competitiveness of local firms – and history has repeatedly shown that neither the aggregate harm nor the ultimate futility of protectionist measures guarantees that governments won’t resort to them.
Assuming an optimistic view of the ability of the rules-based trading system to reach consensus (multilaterally or among a dominant subsect of members) and a pessimistic view of potential government reactions to the service-led development phenomenon, an argument can be made for a robust attempt to negotiate new rules now – before significant interest in restrictions takes shape.
Perhaps the most realistic scenario is that securing the benefits of a development model led by service exports will get some help from the international trading system – but this, with the World Trade Organization (WTO) at its heart, can play an important role in several ways beyond rulemaking.
The service transition can benefit from robust policy support domestically, and the system can play an important role in highlighting needs, sharing best practices, and encouraging regional coordination. Inevitably, frictions and disagreements will arise between trading partners as their regulators and legislators navigate the new seas. The WTO can help defuse tensions and prevent conflict escalation.
Services are becoming ever more important in international commerce. This will have an impact on everything from the nature of protectionism to job displacement in rich nations and new development journeys in emerging markets. And, as service sectors are among the least polluting, it will have important implications for carbon emissions.
Just as policymakers will be looking for answers on how to support this transition, the international development community will need guidance on how it can be of greatest assistance. Is it too much to hope that the WTO could take the helm and steer us through the choppy currents to calmer waters?
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