17 March 2017

The New Geography of Global Economic Power

When the United Kingdom voted on 23 June 2016 to leave the European Union, most people focused on immigration as the root cause. Some said it was xenophobia or even racism. And certainly immigration, xenophobia and racism were major issues in the referendum. But the ultimate cause of the Brexit vote was not immigration. It was economics.

Around 3.2 million non-British EU citizens live in the UK. Two thirds of them are working there. Only 1.2 million British citizens live in the rest of the EU. Most of them are retired. More British citizens work in the United States than work in continental Europe.

Imagine if the Franco-German core of the European economy were like the North-eastern core of the North American economy. In terms of GDP per capita, France and Germany are roughly on the same level as the UK. The North-eastern US is 50 per cent richer. If France and Germany were 50 per cent richer than the UK, instead of 2 million Europeans working in Britain, there might be 2 million Britons working in Europe.

If that were the case, would there have been so many European immigrants in the UK? Would there have been so much anti-immigrant sentiment? Would there have been a vote for Brexit? Britain’s Brexit vote is merely a reflection of larger global economic patterns that create little incentive for Britain to tie itself to the second-rate Western European economy.

Britain’s finance industry has long been more closely tied to New York than it is to Frankfurt or Paris. The rest of the economy may soon follow. Even before Brexit, British investment in continental Europe was declining. British investment in North America is rising.

With Donald Trump promising to fast-track a trade deal with Britain, the UK will hardly be isolated once it leaves the European Union. But the whole idea that trade deals integrate economies is outdated, if it ever made sense at all. Countries are integrated into international networks by the actions of companies. In the contemporary world, countries do not trade with countries. Companies transfer goods within value chains, and when these transfers cross national boundaries they are recorded as “trade”.

From an economic standpoint, Brexit boils down to a question about where British companies most want to do business. Is it in Western Europe, or in North America? Despite nearly half a century of strong institutional pressure to integrate with Western Europe, the EU still takes less than half of the UK’s exports. But exports are really beside the point. These days trade deals – like the EU itself – are really about economic governance. The UK could govern itself, like Australia does. Or it could choose closer integration with the world’s leading economic region: North America.

 

THE NEW ECONOMIC GEOGRAPHY

 

Between 1995 and 2008 global levels of merchandise trade increased from around 20 per cent of global GDP to around 30 per cent. The world globalised as goods (and services) traversed the world as never before in human history. The previous 1913 peak in international trade was dwarfed as new transportation technologies – from leviathan container ships to just-in-time air freight – reshaped global production networks. Now nearly one in three things bought on earth (by value) comes from somewhere else. The era of globalisation has arrived.

And departed? Global trade as a per cent of GDP has been flat since 2008, and an increasing proportion of that trade is trade in intermediate goods. On average around one quarter of the value-added embodied in the world’s exports actually consists of intermediate goods that are then incorporated into products for re-export. But intermediate goods tend not to be sourced globally. They are overwhelmingly drawn from countries’ close regional neighbours.

For countries that are highly integrated into regional production networks the foreign-origin component of exports can be even higher. For many export-processing economies it is nearly one third. The foreign-origin component of exports by value is 32.4 per cent for Poland, 32.2 per cent for China, and 31.7 per cent for Mexico. For smaller countries on the edges of Germany and Japan the numbers are higher still: 41.7 per cent for Korea, 45.3 per cent in the Czech Republic, 46.8 per cent in Slovakia, and 48.7 per cent for Hungary. Only the city- states of Singapore and Luxembourg score higher.

In all of these cases, the main suppliers of imported content are regional trading partners, not far-flung global networks. Countries in South Asia and Latin America that are excluded from regional networks have much lower levels of foreign value-added. The foreign portion of export value for India is just 24.1 per cent, for Indonesia 12.0 per cent, for Brazil 10.8 per cent, and for Argentina 14.1 per cent. For South Africa the figure is 19.5 per cent.

Despite its position just off the coast of continental Europe, the foreign value- added component of the UK’s exports is just 23.0 per cent. This is still well above the level of isolated countries like Australia (14.1 per cent) and New Zealand (16.7 per cent) but slightly below the world average of 24.2 per cent. Most British value chains are either fully internal to the UK or end in the UK. The UK does trade extensively with the European Union, but most of that trade is trade in final products, not true integration. And the EU depends much more on exporting to the UK (£219 billion in 2015) than the other way around (£133 billion).

 

A HIERARCHY OF REGIONS

 

Today’s global economy consists of three major economic regions – North America, Western Europe and East Asia – surrounded by a large number of economically isolated countries. Russia and Central Asia, India and South Asia, the countries of the Middle East and North Africa, the countries of Sub-Saharan Africa, the countries of Central America, and the countries of South America are all isolates in the global economy. All of them trade more with the three major economic regions than they do with their own neighbours.

But the three major economic regions are not equal, or even roughly equal. When we think of the United States as a country and compare it to Germany or Japan, the United States seems to be a slightly richer peer. Gross domestic product (GDP) per capita in the United States is 36 per cent higher than in Germany and 69 per cent higher than in Japan. The differences are substantial.

When the United States is decomposed into its constituent economic units, the differences become overwhelming. The North-eastern United States – the core of the North American economy, running from northern Virginia through Washington, New York and Boston – is 50 per cent richer than Germany and nearly twice as rich as Japan. In economic terms, if Germany were a US state it would be on a par with Alabama. If Japan were a US state it would be Mississippi.

If the UK is destined by geography to be embedded in global value chains, the new economic geography suggests that it should hitch its wagon to North America, not Western Europe. The UK may no longer be a global centre, but if it has to be a periphery it makes more sense to be a periphery of New York than to be a periphery of Alabama (i.e. Germany). The North American economy has a primary core in the North-eastern United States and a secondary core on the West Coast. There is no reason it could not have a third core in England.

Los Angeles is six hours by air from New York. London is only seven. Rail freight takes 5 days to travel from Los Angeles to New York – when not delayed by weather or congestion. London to New York is a reliable 10 days by container trip. Cosmopolitan Americans disparagingly refer to the continent between New York and California as “flyover country”. With more than 30 daily flights in each direction, the New York–London air corridor is the most travelled in the world. In fact, with 4 million annual passengers, a million more people fly between New York and London every year than fly between New York and Los Angeles.

Perhaps more important than the physical geography of trade is the human geography of institutions. The US and UK share more than a language. They share a financial infrastructure, a business culture, a legal heritage and a way of thinking. For many intellectual property based industries, like entertainment and publishing, British firms are already fully integrated into the North American economy. As the post-industrial economy becomes ever more a virtual economy, economic geography will tie the United Kingdom even more closely to North America.

 

ALTERNATIVES FOR ECONOMIC GOVERNANCE

 

Taken together the world’s three major economic regions have a combined GDP of around $60 trillion, constituting some 80 per cent of global economic output. The combined GDP of all of the countries of the world that lie outside these regions is less than that of the United States, the European Union or China alone. As a result, the global economy consists of the three major regions plus a large number of countries that do little more than provide economic feedstocks like energy and foodstuffs to support production in the big three regions. Australia and New Zealand, prosperous though they are, are among those feedstock countries.

Each of the big three economic regions has much more within-region trade among neighbouring countries than external trade with the rest of the world. The big three regions are in effect economic units, regional economies, not collections of national economies that trade with each other. This is most visible in Western Europe, where the European Union has merged 28 countries plus Switzerland and Norway into a single customs area. It is also visible in North America, where NAFTA connects the United States, Canada and Mexico. But it is also happening in Asia, where firms based in Japan, Korea and Taiwan are among the top investors and producers in China and Southeast Asia.

The Western European economic region consists of high value-added centres like the UK, France, Germany, Austria, Switzerland, Italy, the Benelux countries and the Scandinavian countries combined with lower-cost manufacturing and services centres in the eastern European Union countries and Turkey. This region is “Western” European in the sense that it does not include Europe east of the European Union. Countries like Belarus, Russia and Ukraine are not well- integrated into the production networks that emanate from the high value-added centres of Europe. Additional production for the Western European economic region occurs in Latin America, Asia and elsewhere but these production networks do not seem to exhibit strong defining patterns.

The relevant networks of the Western European economic region are almost entirely contained within the European Union and countries that aspire to join the European Union. The European Union directly governs 94 per cent of the total economy of Western Europe (a figure that will fall to 78 per cent once the UK leaves the EU). This means that the majority of the economic region is covered by a governance umbrella that is held by its core members. And whatever Brexiteers may think of the European Union, by global standards it is certainly a well-governed economic zone.

The East Asian economic region consists of high value-added offshore centres like Japan, South Korea, Taiwan, Hong Kong and Singapore combined with the enormous manufacturing base of mainland China. The offshore centres have extensive production of their own but also coordinate enormous investments in mainland China. Additional large-scale offshore production occurs in the Southeast Asian countries of Indonesia, Malaysia, Thailand and Vietnam.

The East Asian economic region is highly integrated economically but poorly integrated politically, with the hard international borders in the East China Sea ensuring that intraregional trade and investment are subject to substantial barriers, especially non-tariff barriers. Since the majority of the region (about two thirds by GDP) is in China, collective economic governance in East Asia is very poor. Overall East Asia has the worst governance and the lowest average GDP per capita of the world’s three major economic regions.

The North American economic region consists of the high value-added centres of the United States and Canada combined with lower-cost manufacturing in the poorer regions of the United States itself and of northern Mexico. Compared to the East Asian and Western European economic regions, the North American economic region has a high level of political integration: the entire region is included in NAFTA, with the United States alone comprising 87 per cent of total NAFTA GDP. Thus although NAFTA has much weaker governance mechanisms than the European Union, the fact that the United States is much more politically-integrated than the European Union combined with the fact that the United States dominates the North American economic region implies that the North American economic region as a whole is more politically-integrated than the Western European region.

The concentration of the North American economy within the United States itself means that economic governance in the region is much more uniform than in either Western Europe or East Asia. It is unlikely (though not impossible) that the post-Brexit UK would join NAFTA, but the UK does not have to join NAFTA to benefit from North America’s economic governance regime. It merely has to align with the United States. Many leading UK industries are already managed on American principles, including banking, accounting, consulting, publishing, advertising, entertainment, art, design and higher education. Freedom of movement notwithstanding, from a practical standpoint it is much easier for British professionals to work in the United States than to work in continental Europe. Western Europe may now do business in English, but England does business like the United States.

 

JOINING THE WINNING TEAM

 

The world’s three major economic regions are not distinguished merely by wealth or size. The unique structural position of the United States in the global economy, buttressed by a century of dominating foreign direct investment flows, has given North America a global reach that far outstrips that of the East Asian and Western European regions. This is not always apparent in trade statistics but it is obvious from ad hoc evidence about the dominance of US multinational firms in global production networks. It is also clear from the continuing pre-eminence of the US dollar.

Western Europe and East Asia may be physically located on the same continent. But it takes a container 30 days at sea to get from Shanghai to Rotterdam. The new Chinese rail service across Eurasia still takes 20 days – and costs three times as much. In contrast, a container takes just 15 days to cross the Pacific from Shanghai to Los Angeles. The idea that China and Japan are in the east is an outmoded, Eurocentric view of the world. East Asia is not to the east of Europe. In the economic geography of world trade, East Asia is to the west of California.

It is perhaps no coincidence that North America’s richest area faces east toward Europe and its second-richest area faces west toward Asia. One might reasonably depict the world’s three major economic regions as a triangular hierarchy, with East Asia and Western Europe on the base and North America at the apex. The rest of the world consists of a mix of rich and poor countries, some of them highly developed, but none of them embedded in structured transnational economic regions. Even Australia and New Zealand, rich though they are, are not deeply enmeshed in dense transnational production networks in the same way as peer countries like the Netherlands and Taiwan. They are economic isolates, excluded from major global production networks. Australian and New Zealand firms are not leaders in any industry that involves complex, multistage production processes.

British firms are different. The FTSE may be dominated by banking and natural resource companies, but the British economy as a whole is much more dynamic. Many of those dynamic middle-tier firms are North American: US and Canadian firms account for 11 per cent of the non-financial value added in the UK economy, on a par with European Union firms. And as with other integration statistics, the US presence in the UK economy has been rising and the EU presence falling – even pre-Brexit. Post-Brexit this trend is likely to accelerate.

 

NO HARD FEELINGS

 

Politics and personal feelings aside, the simple fact is that North America is economically much more dynamic than the European Union. The difference becomes overwhelmingly clear when you look at the online economy of the twenty- first century. Many British people, Londoners especially, may feel European in outlook. But those same Londoners are much more likely to have careers that include spells in New York or Los Angeles than in Paris or Berlin. They may feel European, but they work American.

Brexit was a vote about identity and sovereignty. But identity and sovereignty are both shaped by economics. As the world’s economic structure draws Britain inexorably into the North American orbit, British identity and sovereignty will follow. Identity, because British people will find themselves spending more and more time working in North America or North American companies, interacting with North American social media, and participating (as interested spectators at least) in North American politics. Sovereignty, because the governance rules that most strongly affect British business life will increasingly emanate from Washington, not Brussels.

Leaving the European Union may pose risks of a European backlash, but remaining in the EU would have posed the certainty of increasing conflict between global (i.e. North American) economic governance and the regional rules that govern the European Union. Nor should the UK fear a European backlash. Europeans are fixated on the right to work in Britain because the British economy is as close to the North American as they can get. Brexit will only make Europeans more eager to share in the dynamic, globally-linked UK economy, not less. Europeans do not come to Britain for its Europeanness. They come for its globality.

From an economic standpoint, Brexit should not be understood as Britain leaving the European Union. It should be understood as Britain rejoining the world. The global economic world is centred on North America, the new digital economy overwhelmingly so. It is a very open world that British people intuitively understand. After all, they invented it. Brexit gives the British people an opportunity to return to the global economic centre. They can always vacation in Europe.

 

(Note. An earlier version of this article was published in the Australian monthly journal Quadrant.)






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