Global Economy: Good, Bad, Both?

The global economy refers to 'world-wide economic activity between various countries that are considered intertwined and thus can affect other countries negatively or positively.' This definition, however, fails to capture the larger context and meaning of the global economy.  The global economy is also a term that refers to the reality of today’s economic and business activity – companies and individuals seeking to do business in new markets, empowered by unprecedented access to information, reduced trade barriers, and new buying habits.  In short, enlightened self-interest has driven countries and companies to expand their horizons, creating a truly interdependent global economy.

The evolution of the global economy can also be traced to the systematic removal of trade barriers around the world.  Centuries ago, most economies were dominated by local trade due to lack of information about foreign markets. The U.S. is now the world’s 3^rd largest economy, just behind China. At the end of 2014, China made up 16.48% of the world's purchasing-power adjusted GDP (or $17.632 trillion), and the US had 16.28% (or $17.416 trillion).  Moreover, the European Union now collectively generates more economic activity than the USA. This empirical data is useful in understanding the underlying economic incentives that drive the global economy.  With only 5% of the world’s population and approximately 16% of the GDP, American companies need and want to expand globally to increase revenue and profit.  The same holds for foreign-owned companies and countries who do not want to be limited to their own native markets.

The evolution of the global economy is also a natural response to global companies who see significant opportunity in taking their goods and services to new markets that they had previously not served in a big way.  For many companies, international sales represent more than 50% of their revenue and earnings.  For example, Apple’s foreign sales account for more than 60% of its revenue. The same is true for Exxon-Mobil with over 45% of revenue coming from overseas operations, and even Yum Brands (KFC, Pizza Hut, Taco Bell) where foreign sales of KFC outpace sales in the USA.  In China alone, KFC opened 740 new units and now has more than 4,600 restaurants in over 900 Chinese cities.  Without question, foreign sales are a key driver of American corporate results, and the global economy has positively contributed to their growth, especially over the past two decades.

At its core, the global economy is often seen as consumers buying foreign-manufactured products and foreign companies seeking to establish a global footprint.  To be sure, these are high visibility signs of a truly global economy. But the global economy actually goes much further.  In today’s global economy, investors from all countries are seeking to invest in companies that operate in other countries that have markets that may be more attractive than their own traditional markets.  In many cases, these companies have invested in and moved operations into foreign countries so that their growth is not purely a function of exports to foreign countries.

I had the opportunity to talk to a co-founder of Blue Delta Capital Partners last year (www.bluedeltacapitalpartners.com), as to whether his private equity investment company was influenced by the global economy.  He eagerly shared his views as it applies to his company:

“Even though our fund is focused exclusively on firms supporting the U.S. Federal Government, we have had steadily increasing interest from foreign investors.  They see the U.S. Federal market as an attractive market with better growth prospects than many of their current traditional markets.  They have amazing access to information about spending trends, competition, and risks and want to invest in various segments of the U.S. market.  When it comes to investing their own money, they are country-agnostic and incurably global.  They want their money to chase the best returns, without regard to geographical boundaries.”

[Excerpted from an email interview conducted on October 8, 2014]

The evolution of the global economy has been further spurred by meaningful reduction in trade barriers (the North American Free Trade Act being an example) and the decision of the European countries to adopt a common currency and harmonize their trading regulations and policies.  These are positive changes for citizens of European countries because it facilitates doing business across national boundaries, further strengthening the global economy.

While the growth in global markets has benefited American companies, it has also opened up opportunities for foreign companies.   Now liberated and naturally incentivized to expand into new markets due to lifting of trade barriers and knowledge of global consumer preferences, the global economy has flourished because people and companies are naturally inclined to take advantage of their own comparative advantages. As the Nobel Laureate economist Paul Samuelson noted:

“What did David Ricardo mean when he coined the term comparative advantage? According to the principle of comparative advantage, the gains from trade follow from allowing an economy to specialize. If a country is relatively better at making wine than wool, it makes sense to put more resources into wine, and to export some of the wine to pay for imports of wool. This is even true if that country is the world's best wool producer, since the country will have more of both wool and wine than it would have without trade. A country does not have to be best at anything to gain from trade. The gains follow from specializing in those activities which, at world prices, the country is relatively better at, even though it may not have an absolute advantage in them. Because it is relative advantage that matters, it is meaningless to say a country has a comparative advantage in nothing. The term is one of the most misunderstood ideas in economics, and is often wrongly assumed to mean an absolute advantage compared with other countries.”

[P.A. Samuelson, "The Way of an Economist," in P.A. Samuelson, ed., International Economic Relations: Proceedings of the Third Congress of the International Economic Association, 1969, Macmillan: London, pp. 1-11.]

The theory of comparative advantage is at the core of the global economy.  It drives countries and companies to specialize at what they are good at (Where they have a comparative advantage).  The free flow of information makes it easier than ever to match buyers and sellers and transact business.

The notion of a global economy is truly an evolutionary concept, enabled in large part by the removal of trade barriers, powerful advances in information technology, and adoption of common trading regulations such as is being done by the European Union.  Widespread access to the Internet has broken down language and cultural barriers, exposing potential consumers around the world to new products and services.  While company-to-company trade has been steadily increasing for the past century, the Internet has created a global direct-to-consumer market.  Simply put, it is much easier and less expensive to transact business internationally than it ever was before, and that economic force is the cornerstone of the global economy.

While the global economy has lifted standards of living and provided enormous opportunity to people around the globe, there are still protectionists who believe it is unpatriotic to buy products made in foreign countries.  These protectionists fail to understand basic economic concepts and the fact that in a free economy, competition lowers prices and increases quality.  Individuals who prefer to avoid foreign-produced goods can still do so, but denying that right to others stifles economic growth and reduces buying power among those least capable of affording domestically-produced higher priced goods that are no better than their cheaper, foreign-made alternatives.

The progressive migration from local and national dominated economies to a truly global economy is a positive development for people around the world and for companies who seek to export goods and services.  The global economy increases competition and choice, thus reducing prices.  Standards of living are increased, and employment abuses, such as use of child labor, are at least publicized and subjected to greater scrutiny.  To be sure, there are some negatives, such as the loss of jobs in industries that cannot produce goods and services as competitively as other companies, many of whom may be based overseas. But this is offset by employment growth as companies penetrate newly open global markets that were previously off limits or difficult to serve.  Another negative consequence of the global economy is the tight linkage between national economies and the fragility of the system.  A serious economic issue in one country will now have much more widespread implications for the global economy than ever before. On balance, the Darwinian nature of economic forces – with competition on a global scale driving out inferior or noncompetitive suppliers – is a good trend that also spurs companies and individuals to do better, lest they go out of business. While there are some negative aspects to the global economy, it is largely a good development with the world a far better place with it, than it would be without it.