Mark Carney: The implications of globalization for the economy and
public policy
Remarks by Mr Mark Carney, Governor of the Bank of Canada, to the British Columbia
Chamber of Commerce and the Business Council of British Columbia, Vancouver, British
Columbia, 18 February 2008.
* * *
I am delighted to give my first public address as Governor of the Bank of Canada in
Vancouver, not only because my roots are here in the West, but also because Vancouver
aptly symbolizes the subject of my remarks today - globalization.
I chose to speak about globalization at the outset of my tenure because it will continue to be
one of the forces shaping our economy and economic policy for years to come. Steady
advances in transportation, communication, and information technologies, underpinned by
the more widespread adoption of free-market economic policies, are shrinking the globe and
expanding the global economy. It is incontestable that the current wave of globalization has
been, on balance, of great benefit. Hundreds of millions of people have already been lifted
out of poverty, with the real potential for hundreds of millions more to share their destiny.1
Globalization has also had numerous economic benefits for Canada. The recent period of
international integration has coincided with the second-longest expansion in our nation's
history, characterized by rising real incomes, surging employment, and low, stable, and
predictable inflation. However, these outcomes are not preordained; to reap fully the benefits
of globalization, policy-makers must weigh its implications and respond effectively to its
challenges.
In my time today, I will discuss these policy challenges, particularly those related to the
conduct of monetary policy. First, I will talk about how the current wave of globalization
differs from previous periods of economic integration, and then I will address some of the
economic impacts of globalization. Before concluding, I will also say a few words about the
current outlook for the Canadian economy, which, not surprisingly, is importantly influenced
by global economic developments.
What is different?
In some respects, the current wave of globalization resembles earlier episodes. There have
been occasional periods of intense economic integration over the centuries, most notably
during the Roman Empire and in the latter half of the 19th century. These have shared
several common features: for example, technological innovations that shrank economic
distances (e.g., standardized roads, the telegraph and, more recently, the Internet) and, very
importantly, governments that pursued supportive economic policies. These governments
recognized the long-term benefits of economic integration and were large enough to
internalize the costs - both political and fiscal - of promoting public goods such as the rule of
law; common standards for trade, products, and services; and the liberalization of trade.
Many of their decisions, such as the repeal of the Corn Laws in England, were unpopular at
the time, but ultimately proved beneficial.2 We should all hope that similar courage will begin
to guide participants in the current Doha Development Round of trade negotiations.
So, is there anything different about this period of integration? I would argue that there are
three aspects. First, the sheer scale of the process is unprecedented; second, the relative
size of the emerging economies being integrated into the core of the global economy means
that their policies matter for advanced economies, as well as for their own; and third, the
widespread adoption of supply-chain management by business further enhances the depth
of integration.
In terms of scale, it is safe to say that never in history has economic integration involved so
many people, both in raw numbers and as a percentage of the global population. For
example, when North America and the periphery of Europe were integrated during the latter
half of the 19th century, their total population was half the size of the then-advanced
countries. The comparable ratio for postwar Japan was 10 per cent. Contrast that with China
and India today, which alone represent 2.5 times the current population of advanced
countries.3 Of course, the entire populations of China, India, and other emerging markets are
not being instantly integrated into the global economy. If you adjust for the percentage of the
population in the traded-goods sector, however, the effective global labour supply
quadrupled between 1980 and 2005, with most of the increase taking place after 1990.4 This
trend is set to continue: The globally integrated labour force is projected to double again by
2050.5
Similarly, the scale of cross-border flows of goods, services, and capital is now
unprecedented. The global economy has opened dramatically - merchandise exports now
make up about 20 per cent of global GDP, compared with about 9 per cent at the height of
the last great wave of globalization, roughly a century ago.6 According to research at the
OECD, advances in communications technology mean that up to 1 in 5 services are now
tradable, although this potential has only just begun to be tapped.7 Cross-border capital flows
are now roughly 15 per cent of global GDP, compared with 3 per cent at the turn of the last
century.8
The second difference that characterizes this wave of globalization is that, given the relative
size of emerging markets, their policies matter. For the most part, the economic policies of
emerging-market countries have improved the welfare of both their citizens and our own,
through the gains from trade. With some policies, however, most notably in the degree of
exchange rate flexibility and, by extension, in the conduct of their domestic monetary
policies, some emerging markets have run great risks. In particular, they continue to import,
what is, for them, overly loose monetary policy that will ultimately lead to adjustments in the
real exchange rate through higher domestic inflation, with the attendant economic distortions,
adjustment costs, and risk of a hard landing.
Moreover, at the global level, there are important spillovers of these policies onto other
economies, such as Canada's. Export-promotion strategies underpinned by undervalued
3
For a more complete discussion, see A. Maddison, "World Development and Outlook 1820-2030: Evidence
Submitted to the House of Lords" (20 February 2005). Available at <http://www.ggdc.net/maddison/>.
4
International Monetary Fund, World Economic Outlook (April 2007), 162. Each country's labour force is
weighted by its export-to-GDP ratio.
5
Ibid., 180.
6
See A. Maddison, Monitoring the World Economy, 1820-1992 (OECD, 1995) and C. Alexander and
K. Warwick, "Governments, Exports and Growth: Responding to the Challenges and Opportunities of
Globalisation," The World Economy 30, no.1 (2007), 178.
7
See D. van Welsun and G. Vickery, "Potential Offshoring of ICT-Intensive Using Occupations," (OECD, April
2005).
8
See K. H. O'Rourke and J. G. Williamson (1999), Globalization and History; The Evolution of a
NineteenthCentury Atlantic Economy, and R. Battellino (2006), Regional Capital Flows, a speech to the 6th APEC Future
Economic Leaders Think Tank, Sydney, 28 June.
BIS Review 20/2008
exchange rates are generating unprecedented reserve accumulation, as central banks
intervene to forestall exchange rate adjustment.9 In contrast to earlier periods where
emerging markets imported capital to finance investment, today's largest emerging
economies are important capital exporters, to such an extent that they have been significant
drivers of lower global long-term interest rates. Since the level of long-term interest rates
influences risk appetite and capital allocation, the extent to which they are determined by
non-market forces can lead to distortions. Indeed, the low level and relative stability of
longterm interest rates encouraged investors to "search for yield," which in turn contributed to the
dramatic increase in highly structured credit products, including those backed by U.S.
subprime mortgages.
The third aspect of today's globalization that is different is the relative novelty of global
supply-chain management. Advances in information technologies, specialized production
processes, and reduced communication and transportation costs have all led to a whole new
range of goods and services becoming tradable. For example, over the past 30 years, the
share of imports as a percentage of manufacturing production has tripled to nearly 30 per
cent.10
These developments mean that firms are now able to increase production efficiency in ways
previously unimaginable. In addition to the rising trade in components or intermediate
products, an entirely new class of tradable services - including financial, engineering,
medical, and legal - has emerged. There is reason to believe that these trends will continue.
With these advances, it is easy to imagine a product designed and marketed in Canada, will
be assembled in China, using parts sourced from elsewhere in emerging Asia and supported
by technicians in India. By breaking down production processes along a global supply chain,
firms are better able to find the efficiency gains that have led to increased productivity and
lower prices.11
Integration has had a clear dampening effect on the prices of manufactured goods. In effect,
technology and globalization are facilitating more widespread application of two of the most
powerful forces in economics: the division of labour and comparative advantage. This allows
companies to organize the production process in the most cost-effective way possible, which
maximizes the likelihood that Canada will retain positions in the high-value-added segments
of many industries. A recent analysis by the Conference Board of Canada suggests that, at
least with respect to Asian supply chains, Canadian firms could do more to exploit
opportunities.12
Some economic implications of globalization
At the same time, the rapid increase of manufacturing in emerging markets has led to strong
demand for many commodities, and thus, to steady upward pressure on the prices of many
of the commodities that Canada produces and exports. The combination of lower prices of
our imports and higher prices for our exports means, by definition, an improvement in
Canada's terms of trade. Rising terms of trade alone have bolstered real disposable income
per capita by 8.5 per cent over the past five years, and have contributed to healthier
corporate balance sheets and continued improvement in government fiscal positions.
Canada has adjusted well to the sharp movements in our terms of trade. Through
conversations that we at the Bank have had with business leaders, through the responses to
questions in our Business Outlook Surveys, and through data showing an average annual
increase of 8 per cent in the volume of business investment since 2002, there is clear
evidence that the Canadian economy is becoming increasingly oriented to high-end services.
Within the goods sector, firms are specializing and concentrating on those areas where they
hold a comparative advantage.13
Globalization is commonly charged with being responsible for increasing inequality and
falling wages in certain sectors of industrialized economies, as lower-skilled jobs are shifted
Employment Outlook
offshore. Indeed, the OECD's 2007 noted that the share of labour
income relative to GDP has fallen in a majority of member countries, including Canada, over
the past two decades, while in 16 of the 19 countries where data are available, the earnings
of workers at the top of the wage distribution have risen relative to earnings of those at the
bottom of the distribution since the early 1990s. While globalization has played a role in
these trends, the story is much more complex. There is considerable evidence that
technological change is behind a large part of the declining ratio of labour income to GDP.14
Further, labour income in Canada has continued to rise in recent years because of strong
employment growth.
What is clear is that globalization has affected the makeup of the labour force in many
countries by promoting a shift of lower-skilled, labour-intensive production processes to
emerging markets and encouraging the growth of higher-skilled, knowledge-based
production in industrialized countries. While it is true that this adjustment process can be,
and has been, difficult for certain individuals and firms, the overall picture is quite positive. In
countries where labour markets are flexible, displaced workers have been more able to
reskill or retrain and, on balance, find more productive employment. Since December 2002,
employment in Canada's manufacturing sector has fallen by roughly 14 per cent, or 320,000
jobs, while employment in other goods-producing sectors has risen by roughly 23 per cent, or
382,000 jobs. Further, over the same period, employment in the services sector has risen by
more than 1.4 million jobs. Average hourly earnings have increased over this period at an
average annual pace of 3.3 per cent. Moreover, everyone in our economy benefits from the
lower cost of imports. While Canada's impressive employment performance cannot be
ascribed to globalization per se, clearly globalization has not prevented it. At the same time,
just as globalization has a long way to run, the adjustment process is far from finished. That
is why it is so important for Canada to continue to improve its economic flexibility - a point
that has been made repeatedly in Bank of Canada speeches.
Policy challenges posed by globalization
It is plain from this discussion of the economic impact of globalization that it also has
important implications for the conduct of monetary policy. I will touch briefly on four
implications that are relevant for the Bank of Canada. It should be recognized at the outset,
however, that these implications can be conflicting, and none is relentless, so they need to
be considered carefully.
First, the Bank needs to be mindful of the possibility that movements in the terms of trade
may affect the relationship between core and total CPI inflation. Recall that globalization has
led to lower prices for many manufactured goods and higher prices for many commodities,
particularly energy products. While both of these groups are represented in the total
consumer price index, many energy prices are excluded from our core measure of inflation
because of their volatility. In the pursuit of our 2 per cent target for total CPI, we use our core
measure as an operational guide because it has been a good gauge of the underlying trend
of inflation and has been a better predictor of future changes in the total index than has total
CPI itself. Forthcoming research at the Bank of Canada indicates that this relationship
continues to hold in Canada, although it has diminished in many other countries.15 We will
continue to monitor the stability of this relationship, and the Bank will also continue to look at
a range of measures to assess the underlying trend of inflation. Considerable judgment must
always be applied, and no one measure should be relied on exclusively.
Second, globalization may affect the degree and speed of the pass-through of exchange rate
movements to domestic prices. It is widely believed that globalization acts as a stabilizer that
should dampen exchange rate pass-through because the increased competition faced by
businesses will lead them to compress their margins to remain competitive and absorb rising
costs.16 Eventually, however, local prices should adjust to exchange rate movements, if they
persist. We may, in fact, be seeing this effect here in Canada, since some retailers in the
automotive and book sectors have recently adjusted prices downwards in the face of greater
competitive pressures stemming from the rise of the Canadian dollar.
Third, globalization may have a conflicting influence on productivity. I have already
mentioned how globalization promotes higher productivity by allowing firms to arrange their
production processes in the most cost-effective ways. Again, however, the reality in Canada
is more complex. The large swings in relative prices fed by globalization have sparked a
reallocation of resources between sectors and regions. This reallocation can lead to a
temporary slowing in productivity growth as the adjustments take place. This is particularly
true in the natural resources sector, where investments typically have long lead times, where
a substantial amount of labour has been absorbed, and where high commodity prices have
encouraged the production of more marginal resources. These effects may be behind a
portion of Canada's disappointing productivity record in recent years.17
Fourth, the impact of globalization on market interest rates is an area where economic theory
and reality do not quite align. The increase in the effective labour supply in the global
economy should have raised the return on investment, all other things being equal, and led
to an increased demand for capital to employ this extra labour. This, in turn, would be
expected to lead to higher interest rates. As I mentioned earlier, however, long-term interest
rates around the world have fallen in recent years, partly because of the exchange rate
policies of some emerging markets. There are several other possible explanations for this
phenomenon, including the balance of private savings and investment in emerging-market
economies, itself the product of the economic policies in these countries.18
15
See Bank of Canada, Renewal of the Inflation-Control Target - Background Information (2006) and
J. Hoddenbagh, M. Johnson, and E. Santor, "Total and Core Inflation: Recent International Evidence" (Bank of
Canada Working Paper, forthcoming).
16
There is evidence that import competition dampens markups in Canada. See D. Leung, "Markups in Canada:
Have They Changed and Why?" (Bank of Canada Working Paper, forthcoming).
17
R. Dion, "Interpreting Canada's Productivity Performance in the Past Decade: Lessons from Recent
Research," Bank of Canada Review (Summer 2007): 19-32.
18
Bank of Canada research has pointed to the relative weakness of investment demand as more important than
the relative increase in desired global savings in explaining the low level of interest rates (B. Desroches and
M. Francis, "World Real Interest Rates: A Global Savings and Investment Perspective," Bank of Canada
Working Paper No. 2007-16). The research also found that the key factors explaining movements in savings
and investment were variables that evolve slowly, such as growth of the labour force and age structure of the
population. Other factors may also explain the low interest rates, including the policy choices of some
emerging markets and imperfect development of global financial markets.
BIS Review 20/2008
Given these four effects, some have argued that the large scale of the current globalization is
undermining the effectiveness of monetary policy.19 I disagree. In short, provided that a
country retains a flexible exchange rate, it retains control of its monetary policy. The rate of
inflation in Canada is a function of the effectiveness of our monetary policy in the face of both
global forces and evolving domestic circumstances.
Essentially, the main challenges for monetary policy posed by globalization are: the impact
on the growth of our economy's potential output, and changes in relative prices, such as the
prices for energy or manufactured products. The growth rate of our economy's potential
matters because it affects the balance of supply and demand in the economy. If the effects of
these changes are not addressed by monetary policy, they will affect the degree of
inflationary pressures in the economy. As for relative price changes, the Bank tries to look
through one-off changes, since these only temporarily affect inflation. However, the
"temporary" price-level shifts driven by globalization can last a long time, and the pace of the
shifts can be variable. It is the job of the Bank of Canada to conduct monetary policy in a
manner that takes into account such persistent shocks and ensures that they do not affect
inflation expectations.
Recent economic and financial developments
So how have these different factors been affecting the conduct of monetary policy in
Canada? Many of the factors just discussed featured prominently in the recent Tokyo
meeting of the G-7 finance ministers and central bank governors. Key topics included the
slowdown in the U.S. economy and the related tightening of credit conditions in most
advanced economies. In addition to outlining a series of measures to improve the functioning
of financial markets, my colleagues and I agreed that each country should continue to take
fiscal and monetary policy measures appropriate to their particular economic circumstances.
Canada's current economic circumstances were spelled out in the Bank's Monetary Policy
Report Update
(MPR) last month. In that document, the Bank said that the economy has
been operating above its production capacity, thanks to strong domestic demand. This
demand has been supported by a rise in real incomes, stemming from the gains in Canada's
terms of trade which, as I mentioned earlier, have been driven by globalization. The evolution
of our terms of trade will depend importantly on demand from major emerging markets. The
impact from our terms of trade is one factor that could lead to stronger domestic demand
growth than we had assumed. This is something that we at the Bank will continue to watch
closely.
Another issue that will continue to be important for us is the evolution of the pass-through to
prices of movements in the exchange rate. As I noted earlier, some retailers - notably of
motor vehicles and books - have adjusted prices downwards in the face of greater
competitive pressures stemming from the rise of the Canadian dollar. In the MPR Update,
the Bank said that we expect this to be a one-off movement in prices, but there is a
possibility that there could be greater and more persistent downward pressure on prices than
we assumed.
The Bank also identified the downside risk that the tightening in credit conditions could be
greater and more protracted than assumed. As well, there could be a more prolonged
slowdown in the U.S. economy, exerting a greater drag on Canadian GDP growth and
inflation. These two risks are, of course, related.
In line with our base-case projection and the associated risks, the Bank lowered the target for
the overnight rate by one-quarter of one percentage point on 22 January. This followed a
similar reduction on 4 December, and brought the Bank's key policy rate to 4 per cent. In
making the announcement in January, the Bank said that further monetary stimulus is likely
to be required in the near term to keep aggregate supply and demand in balance and to
return inflation to target over the medium term. As I said recently, the timing and degree of
that stimulus will be determined at future fixed announcement dates, after we have
conducted a thorough analysis of, and applied our judgment to, all information available to us
at that time.
Conclusion
Let me conclude with some brief thoughts about how policy-makers in general should
approach the issue of globalization. There are tremendous benefits from embracing this
integration of markets, but there are adjustment costs as well, in the form of exposing our
economies to global competition and swings in relative prices.
The challenge for policy-makers is to ensure that the benefits of globalization are maximized
and widely shared. In general, this means making sure that policies do not frustrate
marketbased adjustments, but rather are aimed at promoting flexibility in markets - particularly
labour markets. This means maximizing the ability of workers to relocate if they wish,
maintaining appropriate social safety nets that do not discourage employment, and focusing
on lifelong learning and training. Beyond labour markets, governments should focus on
domestic integration. The Trade, Investment and Labour Mobility (TILMA) pact between
British Columbia and Alberta is a good example. Internationally, governments should also
concentrate on removing barriers to trade and investment to maximize the benefits of
globalization. These imperatives will be tested during the current economic slowdown.
From the Bank of Canada's perspective, our challenge is to understand the various ways in
which globalization affects both financial stability (a topic for another speech) and inflation. At
the Bank, we will continue to share our perspectives on globalization and other broader
trends so that individual Canadians, companies, and governments have the necessary
context when making their savings and investment decisions. Finally, in light of the growing
importance of global forces and the risk of negative spillovers from the policies of some
emerging markets, we will continue to use our participation in international fora to shape
global institutions and national policies so that globalization can fulfill its promised benefits for
all.