Ben S Bernanke: Global economic integration - what's new and what's not?
Remarks by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal Reserve
System, at the Federal Reserve Bank of Kansas City's Thirtieth Annual Economic Symposium,
Jackson Hole, Wyoming, 25 August 2006.
* * *
When geographers study the earth and its features, distance is one of the basic measures they use to
describe the patterns they observe. Distance is an elastic concept, however. The physical distance
along a great circle from Wausau, Wisconsin to Wuhan, China is fixed at 7,020 miles. But to an
economist, the distance from Wausau to Wuhan can also be expressed in other metrics, such as the
cost of shipping goods between the two cities, the time it takes for a message to travel those 7,020
miles, and the cost of sending and receiving the message. Economically relevant distances between
Wausau and Wuhan may also depend on what trade economists refer to as the "width of the border,"
which reflects the extra costs of economic exchange imposed by factors such as tariff and nontariff
barriers, as well as costs arising from differences in language, culture, legal traditions, and political
systems.
One of the defining characteristics of the world in which we now live is that, by most economically
relevant measures, distances are shrinking rapidly. The shrinking globe has been a major source of
the powerful wave of worldwide economic integration and increased economic interdependence that
we are currently experiencing. The causes and implications of declining economic distances and
increased economic integration are, of course, the subject of this conference.
The pace of global economic change in recent decades has been breathtaking indeed, and the full
implications of these developments for all aspects of our lives will not be known for many years.
History may provide some guidance, however. The process of global economic integration has been
going on for thousands of years, and the sources and consequences of this integration have often
borne at least a qualitative resemblance to those associated with the current episode. In my remarks
today I will briefly review some past episodes of global economic integration, identify some common
themes, and then put forward some ways in which I see the current episode as similar to and different
from the past. In doing so, I hope to provide some background and context for the important
discussions that we will be having over the next few days.
A short history of global economic integration
As I just noted, the economic integration of widely separated regions is hardly a new phenomenon.
Two thousand years ago, the Romans unified their far-flung empire through an extensive
transportation network and a common language, legal system, and currency. One historian recently
observed that "a citizen of the empire traveling from Britain to the Euphrates in the mid-second century
CE would have found in virtually every town along the journey foods, goods, landscapes, buildings,
institutions, laws, entertainment, and sacred elements not dissimilar to those in his own community."
(Hitchner, 2003, p. 398). This unification promoted trade and economic development.
A millennium and a half later, at the end of the fifteenth century, the voyages of Columbus, Vasco da
Gama, and other explorers initiated a period of trade over even vaster distances. These voyages of
discovery were made possible by advances in European ship technology and navigation, including
improvements in the compass, in the rudder, and in sail design. The sea lanes opened by these
voyages facilitated a thriving intercontinental trade - although the high costs of and the risks
associated with long voyages tended to limit trade to a relatively small set of commodities of high
value relative to their weight and bulk, such as sugar, tobacco, spices, tea, silk, and precious metals.
Much of this trade ultimately came under the control of the trading companies created by the English
and the Dutch. These state-sanctioned monopolies enjoyed - and aggressively protected - high
markups and profits. Influenced by the prevailing mercantilist view of trade as a zero-sum game,
European nation-states competed to dominate lucrative markets, a competition that sometimes spilled
over into military conflict.
The expansion of international trade in the sixteenth century faced some domestic opposition. For
example, in an interesting combination of mercantilist thought and social commentary, the reformer
Martin Luther wrote in 1524:
"But foreign trade, which brings from Calcutta and India and such places wares like
costly silks, articles of gold, and spices - which minister only to ostentation but
serve no useful purpose, and which drain away the money of the land and people -
would not be permitted if we had proper government and princes... God has cast
us Germans off to such an extent that we have to fling our gold and silver into
foreign lands and make the whole world rich, while we ourselves remain beggars."
(James, 2001, p. 8)
Global economic integration took another major leap forward during the period between the end of the
Napoleonic Wars in 1815 and the beginning of World War I. International trade again expanded
significantly as did cross-border flows of financial capital and labor. Once again, new technologies
played an important role in facilitating integration: Transport costs plunged as steam power replaced
the sail and railroads replaced the wagon or the barge, and an ambitious public works project, the
opening of the Suez Canal, significantly reduced travel times between Europe and Asia.
Communication costs likewise fell as the telegraph came into common use. One observer in the late
1860s described the just completed trans-Atlantic telegraph cable as having "annihilated both space
and time in the transmission of intelligence" (Standage, 1998, p. 90). Trade expanded the variety of
available goods, both in Europe and elsewhere, and as the trade monopolies of earlier times were
replaced by intense competition, prices converged globally for a wide range of commodities, including
spices, wheat, cotton, pig iron, and jute (Findlay and O'Rourke, 2002).
The structure of trade during the post-Napoleonic period followed a "core-periphery" pattern.
Capitalrich Western European countries, particularly Britain, were the center, or core, of the trading system
and the international monetary system. Countries in which natural resources and land were relatively
abundant formed the periphery. Manufactured goods, financial capital, and labor tended to flow from
the core to the periphery, with natural resources and agricultural products flowing from the periphery to
the core. The composition of the core and the periphery remained fairly stable, with one important
exception being the United States, which, over the course of the nineteenth century, made the
transition from the periphery to the core. The share of manufactured goods in U.S. exports rose from
less than 30 percent in 1840 to 60 percent in 1913, and the United States became a net exporter of
financial capital beginning in the late 1890s.1
For the most part, government policies during this era fostered openness to trade, capital mobility, and
migration. Britain unilaterally repealed its tariffs on grains (the so-called corn laws) in 1846, and a
series of bilateral treaties subsequently dismantled many barriers to trade in Europe. A growing
appreciation for the principle of comparative advantage, as forcefully articulated by Adam Smith and
David Ricardo, may have made governments more receptive to the view that international trade is not
a zero-sum game but can be beneficial to all participants.
That said, domestic opposition to free trade eventually intensified, as cheap grain from the periphery
put downward pressure on the incomes of landowners in the core. Beginning in the late 1870s, many
European countries raised tariffs, with Britain being a prominent exception. Britain did respond to
protectionist pressures by passing legislation that required that goods be stamped with their country of
origin. This step provided additional grist for trade protesters, however, as the author of one British
anti-free-trade pamphlet in the 1890s lamented that even the pencil he used to write his protest was
marked "made in Germany" (James, 2001, p. 15). In the United States, tariffs on manufactures were
raised in the 1860s to relatively high levels, where they remained until well into the twentieth century.
Despite these increased barriers to the importation of goods, the United States was remarkably open
to immigration throughout this period.
Unfortunately, the international economic integration achieved during the nineteenth century was
largely unraveled in the twentieth by two world wars and the Great Depression. After World War II, the
major powers undertook the difficult tasks of rebuilding both the physical infrastructure and the
international trade and monetary systems. The industrial core - now including an emergent Japan as
well as the United States and Western Europe - ultimately succeeded in restoring a substantial degree
of economic integration, though decades passed before trade as a share of global output reached
preWorld War I levels.
One manifestation of this re-integration was the rise of so-called intra-industry trade. Researchers in
the late-1960s and the 1970s noted that an increasing share of global trade was taking place between
countries with similar resource endowments, trading similar types of goods - mainly manufactured
products traded among industrial countries.2 Unlike international trade in the nineteenth century, these
flows could not be readily explained by the perspectives of Ricardo or of the Swedish economists Eli
Heckscher and Bertil Ohlin that emphasized national differences in endowments of natural resources
or factors of production. In influential work, Paul Krugman and others have since argued that
intraindustry trade can be attributed to firms' efforts to exploit economies of scale, coupled with a taste for
variety by purchasers.
Postwar economic re-integration was supported by several factors, both technological and political.
Technological advances further reduced the costs of transportation and communication, as the air
freight fleet was converted from propeller to jet and intermodal shipping techniques (including
containerization) became common. Telephone communication expanded, and digital electronic
computing came into use. Taken together, these advances allowed an ever-broadening set of
products to be traded internationally. In the policy sphere, tariff barriers - which had been dramatically
increased during the Great Depression - were lowered, with many of these reductions negotiated
within the multilateral framework provided by the General Agreement on Tariffs and Trade.
Globalization was, to some extent, also supported by geopolitical considerations, as economic
integration among the Western market economies became viewed as part of the strategy for waging
the Cold War. However, although trade expanded significantly in the early post-World War II period,
many countries - recalling the exchange-rate and financial crises of the 1930s - adopted regulations
aimed at limiting the mobility of financial capital across national borders.
Several conclusions emerge from this brief historical review. Perhaps the clearest conclusion is that
new technologies that reduce the costs of transportation and communication have been a major factor
supporting global economic integration. Of course, technological advance is itself affected by the
economic incentives for inventive activity; these incentives increase with the size of the market,
creating something of a virtuous circle. For example, in the nineteenth century, the high potential
return to improving communications between Europe and the United States prompted intensive work
to better understand electricity and to improve telegraph technology - efforts that together helped
make the trans-Atlantic cable possible.
A second conclusion from history is that national policy choices may be critical determinants of the
extent of international economic integration. Britain's embrace of free trade and free capital flows
helped to catalyze international integration in the nineteenth century. Fifteenth-century China provides
an opposing example. In the early decades of that century, the Chinese sailed great fleets to the ports
of Asia and East Africa, including ships much larger than those that the Europeans were to use later in
the voyages of discovery. These expeditions apparently had only limited economic impact, however.
Ultimately, internal political struggles led to a curtailment of further Chinese exploration (Findlay,
1992). Evidently, in this case, different choices by political leaders might have led to very different
historical outcomes.
A third observation is that social dislocation, and consequently often social resistance, may result
when economies become more open. An important source of dislocation is that - as the principle of
comparative advantage suggests - the expansion of trade opportunities tends to change the mix of
goods that each country produces and the relative returns to capital and labor. The resulting shifts in
the structure of production impose costs on workers and business owners in some industries and thus
create a constituency that opposes the process of economic integration. More broadly, increased
economic interdependence may also engender opposition by stimulating social or cultural change, or
by being perceived as benefiting some groups much more than others.
The current episode of global economic integration
How does the current wave of global economic integration compare with previous episodes? In a
number of ways, the remarkable economic changes that we observe today are being driven by the
same basic forces and are having similar effects as in the past. Perhaps most important, technological
advances continue to play an important role in facilitating global integration. For example, dramatic
improvements in supply-chain management, made possible by advances in communication and
computer technologies, have significantly reduced the costs of coordinating production among globally
distributed suppliers.
Another common feature of the contemporary economic landscape and the experience of the past is
the continued broadening of the range of products that are viewed as tradable. In part, this broadening
simply reflects the wider range of goods available today - high-tech consumer goods, for example - as
well as ongoing declines in transportation costs. Particularly striking, however, is the extent to which
information and communication technologies now facilitate active international trade in a wide range of
services, from call center operations to sophisticated financial, legal, medical, and engineering
services.
The critical role of government policy in supporting, or at least permitting, global economic integration,
is a third similarity between the past and the present. Progress in trade liberalization has continued in
recent decades - though not always at a steady pace, as the recent Doha Round negotiations
demonstrate. Moreover, the institutional framework supporting global trade, most importantly the
World Trade Organization, has expanded and strengthened over time. Regional frameworks and
agreements, such as the North American Free Trade Agreement and the European Union's "single
market," have also promoted trade. Government restrictions on international capital flows have
generally declined, and the "soft infrastructure" supporting those flows - for example, legal frameworks
and accounting rules - have improved, in part through international cooperation.
In yet another parallel with the past, however, social and political opposition to rapid economic
integration has also emerged. As in the past, much of this opposition is driven by the distributional
impact of changes in the pattern of production, but other concerns have been expressed as well - for
example, about the effects of global economic integration on the environment or on the poorest
countries.
What, then, is new about the current episode? Each observer will have his or her own perspective,
but, to me, four differences between the current wave of global economic integration and past
episodes seem most important. First, the scale and pace of the current episode is unprecedented. For
example, in recent years, global merchandise exports have been above 20 percent of world gross
domestic product, compared with about 8 percent in 1913 and less than 15 percent as recently as
1990; and international financial flows have expanded even more quickly.3 But these data understate
the magnitude of the change that we are now experiencing. The emergence of China, India, and the
former communist-bloc countries implies that the greater part of the earth's population is now
engaged, at least potentially, in the global economy. There are no historical antecedents for this
development. Columbus's voyage to the New World ultimately led to enormous economic change, of
course, but the full integration of the New and the Old Worlds took centuries. In contrast, the economic
opening of China, which began in earnest less than three decades ago, is proceeding rapidly and, if
anything, seems to be accelerating.
Second, the traditional distinction between the core and the periphery is becoming increasingly less
relevant, as the mature industrial economies and the emerging-market economies become more
integrated and interdependent. Notably, the nineteenth-century pattern, in which the core exported
manufactures to the periphery in exchange for commodities, no longer holds, as an increasing share
of world manufacturing capacity is now found in emerging markets. An even more striking aspect of
the breakdown of the core-periphery paradigm is the direction of capital flows: In the nineteenth
century, the country at the center of the world's economy, Great Britain, ran current account surpluses
and exported financial capital to the periphery. Today, the world's largest economy, that of the United
States, runs a current-account deficit, financed to a substantial extent by capital exports from
emerging-market nations.
Third, production processes are becoming geographically fragmented to an unprecedented degree.4
Rather than producing goods in a single process in a single location, firms are increasingly breaking
the production process into discrete steps and performing each step in whatever location allows them
to minimize costs. For example, the U.S. chip producer AMD locates most of its research and
development in California; produces in Texas, Germany, and Japan; does final processing and testing
in Thailand, Singapore, Malaysia, and China; and then sells to markets around the globe. To be sure,
international production chains are not entirely new: In 1911, Henry Ford opened his company's first
overseas factory in Manchester, England, to be closer to a growing source of demand. The factory
produced bodies for the Model A automobile, but imported the chassis and mechanical parts from the
United States for assembly in Manchester. Although examples like this one illustrate the historical
continuity of the process of economic integration, today the geographical extension of production
processes is far more advanced and pervasive than ever before. As an aside, some interesting
economic questions are raised by the fact that in some cases international production chains are
managed almost entirely within a single multinational corporation (roughly 40 percent of U.S.
merchandise trade is classified as intra-firm) and in others they are built through arm's-length
transactions among unrelated firms. But the empirical evidence in both cases suggests that substantial
productivity gains can often be achieved through the development of global supply chains.5
The final item on my list of what is new about the current episode is that international capital markets
have become substantially more mature. Although the net capital flows of a century ago, measured
relative to global output, are comparable to those of the present, gross flows today are much larger.
Moreover, capital flows now take many more forms than in the past: In the nineteenth century,
international portfolio investments were concentrated in the finance of infrastructure projects (such as
the American railroads) and in the purchase of government debt. Today, international investors hold
an array of debt instruments, equities, and derivatives, including claims on a broad range of sectors.
Flows of foreign direct investment are also much larger relative to output than they were fifty or a
hundred years ago.6 As I noted earlier, the increase in capital flows owes much to capital-market
liberalization and factors such as the greater standardization of accounting practices as well as to
technological advances.
Conclusion
By almost any economically relevant metric, distances have shrunk considerably in recent decades.
As a consequence, economically speaking, Wausau and Wuhan are today closer and more
interdependent than ever before. Economic and technological changes are likely to shrink effective
distances still further in coming years, creating the potential for continued improvements in productivity
and living standards and for a reduction in global poverty.
Further progress in global economic integration should not be taken for granted, however. Geopolitical
concerns, including international tensions and the risks of terrorism, already constrain the pace of
worldwide economic integration and may do so even more in the future. And, as in the past, the social
and political opposition to openness can be strong. Although this opposition has many sources, I have
suggested that much of it arises because changes in the patterns of production are likely to threaten
the livelihoods of some workers and the profits of some firms, even when these changes lead to
greater productivity and output overall. The natural reaction of those so affected is to resist change, for
example, by seeking the passage of protectionist measures. The challenge for policymakers is to
ensure that the benefits of global economic integration are sufficiently widely shared - for example, by
helping displaced workers get the necessary training to take advantage of new opportunities - that a
consensus for welfare-enhancing change can be obtained. Building such a consensus may be far from
easy, at both the national and the global levels. However, the effort is well worth making, as the
potential benefits of increased global economic integration are large indeed.
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