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Global macro & geopolitics from a small economy perspective

Responding to globalisation

David Skilling
30 September 2011

This is the latest edition of my fortnightly email series containing reflections on globalisation, policy, and public sector issues. This week I have been reflecting on the impact of the ongoing process of intense globalisation, and the implications for policy-making. So this edition of the Observer contains some thoughts on how governments should think about responding to the challenges and opportunities of an increasingly global economy.

Some context
The latest phase of globalisation that started about 60 years ago continues to intensify. Globalisation now affects large parts of most economies through trade in goods and (increasingly) services, as well as cross-border flows of capital, firms, and people. And the entry of China and other emerging markets into the global economy over the past few decades, a process which is still in its early stages, has super-charged this process. There are risks around the trajectory to be sure, but a genuinely global economy is emerging powered by technology and strong commercial incentives – as well as policy. Outside of Pyongyang (and probably even there) very few sectors or places are left untouched.

The world is more global, more inter-connected, and more rapidly moving. This has many well-documented positive features, but also raises a series of challenges for policy-makers. To name just a few: the operation of global markets has placed pressure on the income distribution and labour markets across many advanced economies (due in part to declining competitiveness in a range of higher wage tradables sectors); smaller or peripheral regions have been exposed to the exit of mobile companies and people due to the agglomeration effect (a flat world does not lead to a flat distribution of economic activity); and an increased incidence of systemic shocks in both the financial and real sectors as economies have become more tightly linked together (The Economist noted recently that the weekly correlation between 23 developed country stock-markets had risen from 0.5 to a remarkable 0.8 over the past 30 years). None of this is brand new, but the implications of globalisation are reaching further into individual economies, and with greater impact. There is always a chance that globalisation will reverse, or that these pressures will moderate substantially, but that does not seem like a very good bet to make.

There is no such thing as domestic policy any more
Much of the current policy attention is focused on digging countries out of the crisis, but dealing with the structural challenges and opportunities presented by this latest phase of globalisation should be the most important policy priority for advanced economy governments. How should governments position their countries in this rapidly and disruptively changing global context? This will involve much more than just getting the policy fundamentals right, although this needs to be done. I would suggest three areas for particular attention. First, determining where your economy can sustain competitive advantage and investing in these areas; new growth engines will be required in many countries. Second, strengthening the resilience of your economy so that risks are either avoided or managed efficiently; reducing deficits, building robust social security systems, and improving household balance sheet positions are important priorities. And third, developing an appropriate portfolio of external economic and political relationships in what is becoming a more competitive and fragmented global environment – ironically, globalisation is placing many of the multilateral institutions like the WTO under real stress.

A key difference in this phase of globalisation is that it affects all areas of policy – from fiscal management, to education policy and the design of social security, to infrastructure and R&D policy, and beyond. Local context does matter, and individual countries do need to fashion their own solutions, but the global environment should be central to national policy decision-making rather than a secondary consideration. Responding appropriately to this more challenging world will require an investment in strategic capacity in public sectors across the advanced economies. Governments need to understand the global dynamics at work, and develop medium-term strategies that will enable them to manage risks and seize opportunities. And the stakes are high. A failure to respond adequately may lead to increased risk exposures, economic performance that is below potential, as well as increasing social and political stress e.g. due to rising inequality. Previous periods of sustained slow or volatile growth show that social and political consensus may be surprisingly fragile.

Small countries can provide insight
There are many strengths in the advanced economies, but changes need to be made in order for them to compete successfully and stay at the frontier. Policy approaches need to reflect the changing world. There is no ‘one size fits all’ approach to this, and countries have meaningful choices about how they respond. To get some sense of what this may look like, it is instructive to consider small, developed countries. Small countries, say those with populations of 20 million people or under, have been living in this global reality for longer, as larger parts of their economies are directly exposed to these global forces and they therefore have more experience in responding to these challenges.

In their own ways, many small countries have invested heavily behind areas of competitive advantage – they have high levels of R&D spending, very well-regarded education systems, and coherent approaches to industry policy. And they have paid real attention to strengthening their risk-bearing capacity – Singapore has built large reserves it can deploy, the Nordics have well-developed safety nets, and New Zealand has flexible, efficient markets which make it easier to absorb negative shocks. But even in many of these relatively successful small countries, there is a sense that change is needed. The strategies that have been successfully deployed in the past may not work so well in this increasingly complex and competitive world. British Nobel Laureate Sir John Hicks once remarked that “the best of all monopoly profits is a quiet life”. No such luck for policy-makers in advanced economies. Back to work!