# The Process of Globalization - Principles of Management

Globalization is the process whereby national economies and business systems are becomingdeeply interlinked with each other. The world is moving away from relatively independentnational economies toward a single global system. The process of globalization,however, has markedly accelerated since the 1980s. There are three main reasons for this:the spread of market-based economic systems, the decline of barriers to international tradeand foreign direct investment, and falling costs of communication and transportation.

In a market economy, such as that of the United States, most businesses are privatelyowned (as opposed to being owned by the state); prices are set by the interaction of supplyand demand; and government regulation is limited to ensuring that competition betweenindividual enterprises is free and fair and that the system does not produce outcomes judgedto be unacceptable by society (poor working conditions, false advertising, harmful industrialpollution).

Until recently only a minority of countries operated with market-based systems. As little as 25 years ago much of the world’s population lived in socialist economies. There mostbusinesses were owned by the state; private producers were excluded from certain industrialand commercial activities; prices were set by the state; and state planners decided what wasproduced where, in what quantity, and by whom. China, Russia, and most of Eastern Europeoperated with tightly controlled socialist economies.

In addition, the economies of many othernations, from India and Brazil to Britain and Sweden, had significant socialist elements insome sectors. In Britain, for example, 30 years ago state-owned enterprises dominated manysectors of the economy, including steelmaking, shipbuilding, coal mining, transportation, andtelecommunications services.

By their nature, socialist economies are antithetical to globalization. They inhibit ratherthan encourage cross-border trade and investment. Foreign businesses are excluded frommany sectors of the economy, if not the entireeconomy, and state-owned enterprises oftenfocus inward on their own economy.

In the 1970s, for example, Britain’s telecommunicationsindustry was monopolized by BritishTelecom, which focused exclusively on providingtelecommunications services to theBritish economy. No other telecommunicationscompanies were allowed to compete inBritain, and British Telecom had no overseasventures.

Socialist economies trace their roots toMarxist-inspired political movements, whichadvocate that the “commanding heights” ofan economy should be controlled by the stateand managed in the public interest.

By the 1970s it was apparent that this ideology hadfailed to deliver on its promise to improve thelot of working people. Indeed, the oppositeseemed to be the case, with socialist economieslagging market economies in economicgrowth rates and living standards. Consequently,by the early 1980s a pronouncedmove was under way in many nations from socialism toward market-based economics.

The movement started in Britain, spreadthroughout the social democratic states ofWestern Europe, and following the collapseof Communism in Eastern Europe and theformer Soviet Union, spread into EasternEurope and Russia by the early 1990s.

By themid-1990s market-based systems werespreading worldwide. Large countries suchas India and Brazil had embraced marketbasedeconomic reforms, and even several nominally Communist nations, including mostnotably China, moved rapidly toward market based systems. By 2005, according to anannual survey conducted by the Heritage Foundation, market-based economic systems weremore widespread than at any time in modern history.

The shift toward market-based systems has four main elements: privatization of stateowned enterprises, dismemberment of former state-owned monopolies, deregulation ofmarkets (including abandonment of price controls and laws restricting investment byforeign enterprises), and establishment of a legal system that supports private enterpriseand protects property rights.

For example, in Brazil the state-owned telecommunicationsmonopoly was privatized and split into 12 separate companies that could compete witheach other; the government also allowed foreign telecommunications companies to enterthe Brazilian market.

In sum, the worldwide shift toward market-based economic systems has supported globalization.Market economies are more open to foreign investment and international trade thanthe socialist alternative. Moreover, the transformation of economies such as China’s andIndia’s to more open systems has created a plethora of opportunities and threats for Western businesses.

Outsourcing of manufacturing and service activities to these nations has accelerated,as have investments in these nations. China in particular has become an engine of globaleconomic growth, a major market for many imports (particularly commodities such as oil),and a source of substantial exports.

FALLING BARRIERS TO TRADE AND INVESTMENT

A key tenet of market-based economic systems is the belief that removing barriers to internationaltrade and foreign direct investment is in the best interests of all nations that participatein a global economic system. International trade occurs whenever a good or service issold across national borders. When Boeing sells planes to Japan Airlines, international tradehas occurred. Foreign direct investment refers to investments by a company based in onenation in business activities in another nation.

When Ford builds a car factory in Russia, as itdid in 2003, foreign direct investment has occurred. The global shift toward market-basedsystems has been accompanied by a decline in barriers to international trade and foreigndirect investment, a surge in such trade and investment, and an increase in the economic interdependencebetween nations.

Trade barriers take two main forms: the application of tariffs to imports from a foreigncountry and quotas. Tariffs are taxes on imports, which raise their prices and make them lessattractive. Quotas are limits on the number of items of a good that can be imported from aforeign nation.

In 1947 nineteen developed nations signed a treaty known as the GeneralAgreement on Tariffs and Trade (or GATT), which committed the signatories to a progressivereduction in trade barriers on manufactured goods. In 1995 the GATT was superseded by theWorld Trade Organization (WTO).Over 120 nations are now members of the WTO, including all significant trading nations.

Asa result of efforts by the GATT and WTO, tariff rates have tumbled and most quotas on importsof manufactured goods into developed nations have been abolished. Between 1950 and 2002 theaverage tariff rate on manufactured goods imported into the United States fell from 14 percentto 4 percent; in Germany tariffs fell from 26 percent to 4 percent; and in Britain they droppedfrom 24 percent to 4 percent.

The WTO is now pushing forward with negotiations to reduce orremove tariffs on trade in agricultural products and a wide range of services. Although progresshas been slow, agreement may be reached by the end of this decade.

In addition to global agreements brokered by the WTO, there has been a sharp increase inregional trade agreements to remove barriers to trade and foreign direct investmentbetween adjacent nations. The most notable of these has been the European Union (EU),which now has 25 member nations.

The EU has progressively removed barriers to trade, investment,and labor flows between member nations, creating a continental economy similar inscale and scope to that of the United States. The North American Free Trade Agreement(NAFTA) between the United States, Canada, and Mexico is another significant regional tradeagreement. Established in 1994, by 2004 NAFTA had removed tariffs on 99 percent of thegoods traded between the three countries.

Although both the WTO and various regional groupings have made progress in removingbarriers to foreign direct investment (FDI), so far much of the reduction in barriers to FDI has come from bilateral agreements. As of 2004 there were 2,392 such treaties in the world involving more than 160 countries—a 12-fold increase from the 181 treaties that existed in 1980. 9 According to the United Nations, some 93 percent of the 2,156 changes made worldwide between 1991 and 2004 in the laws governing foreign direct investment created a more favorable environment for FDI.

TUMBLING COMMUNICATION AND TRANSPORTATION COSTS

The lowering of barriers to international trade and FDI made globalization a theoretical possibility; technological change has made it a tangible reality. Over the past 30 years, global communications have been revolutionized by developments in satellite, optical fiber, and wireless technologies, as well as the Internet. The costs of global communications are plummeting, which lowers the costs of coordinating and controlling a global organization.

Between 1930 and 1990 the cost of a three-minute phone call between New York and London fell from $244.65 to$3.32. By 1998 it had plunged to just 36 cents for consumers, and much lowerrates were available for businesses. Indeed, over the Internet the cost of an internationalphone call is rapidly plummeting toward just a few cents per minute.

The rapid growth of the World Wide Web is the latest expression of this development. In 1990 fewer than 1 million users were connected to the Internet. By 1995 the figure had risen to 50 million. By 2007 the Internet may have more than 1.47 billion users, or about 25 percent of the world’s population. 13 The World Wide Web has developed into the information backbone of the global economy. Web-based transactions hit $657 billion in 2000 (up from nothing in 1994) and reached some$6.8 trillion in 2004.

Included in the expanding volume of Web-based traffic is a growing percentage of cross border trade. Viewed globally, the Web is emerging as an equalizer. It rolls back some constraints of location, scale, and time zones. 15 The Web makes it much easier for buyers and sellers to find each other, wherever they may be located and whatever their size. The Web allows both small and large businesses to expand their global presence at a lower cost than ever before.

In addition to developments in communication technology, several major innovations in transportation technology have occurred since the 1950s. The most important are probably the development of commercial jet aircraft and superfreighters and the introduction of containerization, which simplifies transshipment from one mode of transport to another. The advent of commercial jet travel, by reducing the time needed to get from one location to another, has effectively shrunk the globe. In terms of travel time, New York is now closer to Tokyo than it was to Philadelphia in the colonial days.

Containerization has revolutionized the transportation business, significantly lowering the costs of shipping goods over long distances. Before the advent of containerization in the 1970s and 1980s, moving goods from one mode of transport to another was labor-intensive, lengthy, and costly.

It could take days and several hundred workers to unload a ship and reload its goods onto trucks and trains. With containerization the whole process can be executed by a handful of workers in a couple of days. Since 1980 the world’s containership fleet has more than quadrupled, reflecting in part the growing volume of international trade and in part the switch to this mode of transportation.

As a result of the efficiency gains associated with containerization,transportation costs have plummeted, making itmuch more economical to ship goods around the globe and thereby helping to drive globalization. Between 1920 and 1990 the average ocean freight and port charges per ton of U.S. export and import cargo fell from $95 to$29 (in 1990 dollars). The cost of shipping freight per ton–mile on railroads in the United States fell from 3.04 cents in 1985 to 2.3 cents in 2000, largely as a result of efficiency gains from the widespread use of containers.

An increased share of cargo now travels by air. Between 1955 and 1999 average air transportation revenue per ton–kilometer fell by more than 80 percent. Reflecting the falling cost of airfreight, by the early 2000s air shipments accounted for 28 percent of the value of U.S. trade, up from 7 percent in 1965.