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Richard Baldwin describes how digital technology is allowing people and companies to arbitrage large relative price differences in wages across countries, offering an enormous export opportunity for developing nations.
Globalisation leapt forward in the late 19th century when steam power slashed the costs of moving goods internationally. This ‘old globalisation’ came in two waves. Globalisation 1.0 started in 1820 and ended at the start of WWI, and Globalisation 2.0 began after WWII and ended around 1990. 1 In between, globalisation retreated.
Old globalisation was especially beneficial to today’s rich nations. The G7 (France, Germany, Italy, Britain, US, Japan, and Canada) saw rapid growth of their exports, incomes, and industry compared to today's poor nations. This led to what Kenneth Pomeranz, a historian, calls the Great Divergence.
The G7’s share of world GDP soared from one-fifth in 1820 to two-thirds in 1988. Its share of world trade rose to more than 50% (Figure 1). Enormous differences in income between rich and poor nations first emerged at this time.
Note: Gross domestic product (GDP) is a measure of a country’s total economic output and income.
Source: Author’s elaboration of Maddison online data.
The impact of Globalisation 1.0 on the global distribution of industry was equally shocking, as Figure 2 shows. Britain was the first industrialiser. It maintained a massive lead until 1900, when it was surpassed by the US. The other G7 nations took off in the mid-to-late 1800s. Since the emergence of human civilisation, China, India-Pakistan and other ancient nations had been the leading industrial powers. But as the G7 industrialised, these ancient nations de-industrialised.
Source: Author’s elaboration of data from Bairoch (1982, Table 9).
Globalisation 1.0 drove northern industrialisation and southern de-industrialisation. This is not as widely known as it should be, but it has long been recognised. As Simon Kuznets wrote in 1965:
“Before the 19th century and perhaps not much before it, some presently underdeveloped countries, notably China and parts of India, were believed by Europeans to be more highly developed than Europe” (Kuznets 1965:20, cited in Baldwin and Martin 1999). 2
Globalisation leaped forward again in the late 20th century when information and communication technologies (ICT) radically lowered the cost of moving ideas internationally. This ‘new globalisation’, or Globalisation 3.0, had dramatically different effects on world income (GDP) shares, as can be seen from Figure 1. In just 20 years, the G7 share of world GDP plummeted to 50%, and its share of trade to 32%. This trend, which might be called the 'Great Convergence', is surely the dominant economic fact of the last 20 or 30 years.
What happened to the landscape of global manufacturing? Figure 3 shows that the G7 nations lost share gradually between 1970 and 1990, followed by an accelerated decline from 1990. To where did manufacturing go? Just six developing nations – which we might call the ‘Rapidly Industrialising 6’, or I6 for short – accounted for almost all of it. The I6 are China, Korea, India, Poland, Indonesia and Thailand. China stands out. It gained almost 16 percentage points of world manufacturing in just 20 years.
Source: UNSTAT.org.
To understand why globalisation today acts differently to its effect in the 20th century, we need a broader framework for thinking about globalisation and the things that drive it. This was the theme of my 2016 book, The Great Convergence: Information Technology and the New Globalisation.
This framework also helps us think about the effect that Globalisation 4.0 will have.
Economic globalisation can be defined as all the things that happen when:
move from one nation to another. Globalisation matters because these flows affect our jobs, salaries, income distributions, and so on. (Many more things cross borders, but these are the main flows we are interested in when we analyse economic globalisation.)
But this list is too long. We should simplify to clarify. As Karl Popper said: “Science may be described as the art of systematic over-simplification.” So if we want to understand how the flows affect economies and people, it is useful to narrow the list.
Capital is quite different from the other flows and so we set it aside. When services cross borders, they are either ideas (say, architectural plans) or embedded in goods (say, diamonds that have been skilfully cut in India). This means we can lump services in with either ideas and goods. this leaves us with three flows: goods, ideas, and people.
The next natural question is, what drives globalisation? The answer is equally simple. Globalisation is driven by arbitrage.
When a good is relatively cheap in Germany compared to China, then other goods are relatively cheap in China compared to Germany. It's a logical inevitability. For example, if good 1 is relatively cheap compared to good 2 in Germany, then good 2 must be relatively cheap compared to good 1 in China.
When companies exploit price differences – buying low and selling high – we get international trade. Companies buy what is relatively cheap in Germany and sell it in China and buy what is relatively cheap in China and sell it in Germany. Trade is driven by a two-way buy-low, sell-high arbitrage. This is not a new idea – David Ricardo was writing about it in 1817. There is also arbitrage in ideas and people. As we saw, arbitrage of knowhow was particularly important in Globalisation 3.0.
The arbitrage of the three flows is limited by three costs.
Globalisation has been driven by reductions in the costs of moving goods, ideas and people, because when these costs fall, so does the cost of separating production and consumption geographically. But, to understand globalisation, we need to distinguish the costs of separation for each. Since the early 19th century, all three have fallen, but not at the same time. Shipping costs fell dramatically 150 years before communication costs did. Face-to-face interactions remain costly, even today. This shaped how globalisation evolved.
To understand this, we can be guided in a gallop through the history of trade by a thought framework that I call the 'three cascading constraints' (3CC) view of globalisation.
When transportation involved wind power by sea, and animal power by land, almost nothing could be shipped at a profit over a long distance. The high cost of moving goods, people and ideas created three constraints that bound together the production and consumption of goods. Therefore, apart from elite goods and essential raw materials, most things that people consumed were made within walking distance of their homes. We know from books and paintings that royalty and the rich could enjoy goods made far away, but most people lived in villages. For the rest, consumption meant locally made food, shelter, and clothing.
This isolation meant that the world economy was little more than a patchwork of village-level economies. The extreme separation of production hindered innovation, because small-scale production meant innovation was worth little to the innovator, and their dispersion meant that it was difficult for innovation to spread quickly. Modern growth, in other words, was stymied until Globalisation 1.0 took off.
The cost of moving goods was the first of the three to fall dramatically. From the early 19th century, steam power and transport technologies improved in a process that helped create, and was helped by, the Industrial Revolution.
With cheaper international shipping, more people bought goods from far away. Kevin O’Rourke and Jeff Williamson, two economists of the history of trade, date this to 1820. But while shipping got cheaper, the cost of moving ideas and people fell much less. This unbalanced reduction in arbitrage costs triggered a sequence of changes that had a huge effect on the global economy:
Globalisation accelerated again around 1990, when the ICT revolution radically lowered the cost of moving ideas. Globalisation’s second unbundling – the geographic separation of each manufacturing stage, organised in 'global value chains' (GVCs) – became feasible when the ICT revolution made it possible to organise complex activities at distance. The north-south wage gap inherited from the first unbundling made this offshoring profitable.
Nature abhors a vacuum, economies abhor imbalances. It became cheaper to move ideas, and so this inevitably triggered massive north-to-south flows of knowhow, which reconfigured the world economy as shown by the red lines in Figure 1. This new-style globalisation – where high-tech moved to places where there was low-wage labour – turned the first unbundling on its head. It de-industrialised the north and industrialised the south. Growth slowed in the north and accelerated in the south.
In short, it produced the Great Convergence.
The knowledge that is moving north to south mostly belongs to firms based in the G7. Firms in the G7 have invested in GVCs to ensure that they profit from the new ICT-enabled possibilities. The 21st-century contours of knowledge are increasingly defined by the geography of the GVCs, rather than the geography of nations.
The 3CC view of globalisation argues that this outcome depends on the cost of moving people, not goods or ideas. Aeroplane fares have fallen, but the time-cost of travel has continued to rise because we need to factor in the salaries of managers and technicians. Since it is still expensive to move people around – and international production networks still need people to move among facilities – most advanced manufacturing still occurs in nations that are close to the G7 industrial powerhouses, especially Germany, Japan and the US. India is an exception, but this is because India has engaged in international production networks for which face-to-face contact is less important.
The industrialisation impact of the second unbundling was hyper-concentrated, but the Great Convergence is much broader because of the knock-on effects of the rapid industrialisation of the I6. About half of the world's population lives in the I6, so rapid income growth has triggered a boom in demand for raw materials. This, in turn, triggered the ‘commodity super-cycle’ that led to growth take-offs in commodity-exporting nations. In other words, the second unbundling (Globalisation 3.0) drove growth in many developing nations that were untouched directly by GVCs.
I have summarised the 3CC narrative in Figure 4. It's clear that a third unbundling becomes possible if face-to-face costs plummet. And that, in my view, is what Globalisation 4.0 is all about.
Globalisation is, I believe, in for a radical new transformation. This will happen if the cost of face-to-face interaction falls as much as the cost of moving ideas has in the recent past. This will allow a third unbundling. This will be the unbundling of service workers and service work, or to put it differently, it makes it possible to separate labour services geographically from the labourers.
Arbitrage of goods and ideas will continue, but there will be a new, disruptive aspect called 'tele-migration'. People will sit in one nation, while working in offices in another nation.
There is a simple driving force for this arbitrage. Salaries and wages for this type of work are much higher in rich nations. Hundreds of millions, maybe billions, of people in poor nations would like to earn those wages. Today that is not technically possible, because there is a high face-to-face cost, and we still need in-person interactions in many service and professional jobs. If digital technology relaxes this third constraint on the global arbitrage of wage-rate differences, as I think this will, it would be a big change.
If digital technology allows people in poor nations to offer their labour services in advanced economies without actually having to be there, a lot of people in advanced economies could lose their jobs. The necessary technology is already on the way. This is the topic of my new book, The Globotics Upheaval: Globalisation, Robotics and the Future of Work.
The service sector in G7 nations has been shielded from globalisation because most services require face-to-face contact. Times are changing.
The third unbundling is unfolding before our eyes. It is all about processing and transmitting information. Laws of physics governing goods do not govern data. The explosive growth of digital technology creates the possibility of remote intelligence (RI). Digital technology is tearing down the barriers to arbitrage in labour services.
Firms already hire remote knowledge workers abroad at lower wages. As more companies in rich nations source labour this way, the matchmaking network will grow. Many companies in the US and Europe seem unaware of the possibilities, or maybe they are hesitant to explore what the consequences may be. But once a firm’s competitors start using low-cost foreign labour, competition will accelerate the process.
Talented foreign workers will increasingly use digital platforms like Upwork.com, looking for work, and companies that use them will join the platforms, looking for remote workers. My guess is that tipping-point economics will define the progress of global outsourcing of services. Once people begin to trust these platforms – as they have rapidly come to trust internet services like Airbnb and Uber – it will snowball into something very big, very fast.
The comparative advantage of most developing nations comes from labour that is, quality-adjusted, still cheap. Mostly, the only way they exploit it is to use their labour to make a thing, and then ship that thing across borders. Since manufacturing is subject to large agglomeration economies, and requires that manufacturers get many things right, only a handful of developing nations can really transform their economies based on manufactured exports alone. Most that have succeeded have done so by joining the supply chains that were clustered in G7 nations.
Tele-migration will allow people with skills in developing nations to export their services directly. This may allow the emerging market miracle to continue, but also to spread to many nations that until now have only been able to export commodities.
The first two globalisations helped the G7 nations and hindered the developing nations – at least in a relative sense. Until 1990, most rich nations grew faster than most poor nations. This is because it was easy to ship goods, but difficult to ship knowhow.
Offshoring manufacturing fostered innovation and rising competitiveness in the G7 nations, but the opposite in developing nations. Coordinating complex activities was too expensive, and so the knowledge stayed in the G7, despite the very large imbalances. The ICT revolution opened a way for G7 firms to arbitrage the big differences in knowhow-to-labour ratios that were responsible for wage differences.
Now digital technology is allowing people and companies to arbitrage large relative price differences in wages. This will be an enormous export opportunity for developing nations – especially ones, like India and China, that have fast internet in urban areas and millions of workers with recognisable skills that companies and people in rich countries would like to buy. Tele-migration will also be an export opportunity for many in the rich nations since competition in services is not always won by the cheapest. Quality and reliability still matter.
Will the Great Convergence continue? Will the G7’s share of world GDP continue to decline, and India’s and China’s continue to rise? The answer to both questions is yes. The nature of future globalisation will great accelerate the process.
Baldwin, R (2016), The Great Convergence: Information Technology and the New Globalization,Belknap Press of Harvard University Press.
Baldwin, R (2019), The Globotics Upheaval: Globalisation, Robotics and the Future of Work, Oxford University Press.
Baldwin, R, P Martin and G Ottaviano (2001), "Global Income Divergence, Trade, and Industrialization: The Geography of Growth Take-Offs", Journal of Economic Growth 6(1): 5-37.
Braudel, F (1984), Civilisation and Capitalism, 15th-18th Century: The Perspective of the World. vol 3, Harper and Row.
Chaudhuri, K N (1966), "India’s Foreign Trade and the Cessation of the East India Company’s Trading Activities, 1828-40", Economic History Review 19(2): 345-63.
Kuznets, S (1965), Economic Growth and Structure, Selected Essays, Heinemann.
