Analytical approaches to globalization

1.3.1. Macroeconomic level

Globalization is a highly complex phenomenon requiring diversifi ed tools of economic analysis. It infl uences both the short-term and long-term behavior of economic agents. In the short-run in the macroeconomic context the most obvious tools to use are the aggregate demand (AD) schedule and the IS-LM-BP model (Figure 1.3 a). AD in its simplest defi nition is a sum of expenditure for consumption (C), investments (I), government expenditure (G) and net ex-ports (NX): AD = C I + G + NX. It systemizes various areas of an economy infl u-enced by globalization that could be studied within social science (see Table 1.1).

12 Th ey require government interventions. In the globalized economy such individual in-terventions are bound to be ineffi cient. Regional integration agreements can be seen as one of the remedies for global economy challenges.

Th e IS-LM-BP¹³ (Figure 1.3a) in the globalization context can be used to show the impact of a growing money supply (rightward shift of LM schedule) and deep-ening global fi nancial markets integration (fl atter BP schedule). Th e pre-crisis combination of low interest rates and low infl ation contributed to a strong global expansion of consumption and investments (fi xed and residential) and to a low cost in public sector borrowing (Chapter 3).

Th e impact of globalization can be systemized in a complete model (Fig-ure 1.3b) as well. Th e short-run aggregate supply (SRAS) schedule is a combina-tion of output Y and price level P; it captures the eff ect of natural level of output _ Y and the price diff erence (P – P*) on current output level – Y (1.1):

Y = F[Y (P – P ^e)] = SRAS, (1.1) where: _

Y – natural level of output, P ^e – expected level of prices.

Th e recent stage of globalization and in particular the entrance of India and China into world economic relations made the SRAS schedule fl atter (SRAS' ).

When entering the global economy in 2000 both countries had about 29% and over 45% of the world’s skilled and unskilled labor resources respectively [Salva-tore 2007, p. 130]. Th eir joint capital endownemet was relatively low at that time (over 11% of the world’s capital) but the Chinese accumulation rate had been very high since then, enabling a sizable increase in capital stock per worker. Th is positive supply shock exerted downward pressure on both current (P) and

13 Th e IS schedule represents goods market equilibrium conditions, the LM shows combi-nations of interests rates (R) and output (Y) securing money market equilibrium and the BP line indicates balance of payments equilibrium.

Figure 1.3. Impact of globalization

a. IS-LM-BP model b. SRAS-LRAS-AD model

0

pected price level – P ^e; in an extreme case the SRAS', especially for manufactured goods, could be even presented as pushed down below the pre-entrance level.¹⁴

Th e long-run aggregate supply (LRAS) does not depend on prices. Th e LRAS schedule is vertical (Figure 1.3 b); this means that output depends on capital (K), labor (L) and technology (T) (1.2):

LRAS = f (K, L, T) = Y₀. (1.2)

Th e accumulated entrance of China, India and other developing countries into the world’s economic relations meant that globally availably L and K increased, shift ing LRAS rightwards. In the case of China this supply eff ect was even mag-nifi ed due to its very high investment rate and technological development.

1.3.2. Mezzo and micro aspects of globalization

Globalization and liberalization of entrance rules have a strong impact on com-petitive pressure on all segments of goods and services markets. Th is dominant feature of the latest stage of globalization was magnifi ed in the context of the Sin-gle European Market (SEM) that was launched in the mid 1980s. and was pro-claimed completed at the beginning of the 1990s [Musiałkowska et al. 2012]. Th e SEM was supplemented by a number of EU regulations and directives concerning Trade, Competition and Industry Policies eliminating or substantially reducing national discretionary economic policy measures. Th us, it was this highly com-petitive environment which the Central European New Member States joined in 2004. Its simplifi ed graphic presentation is shown in Figure 1.4.

Th e horizontal axis in Figure 1.4 measures the number of fi rms (N) on the mar-ket, while the vertical axis indicates price level (P) and the average or per unit cost of production (AC). In Figure 1.4 all fi rms sell at the same price. Th e background assumption for the schedule in Figure 1.4 is that fi rms are symmetric or face the same internal and external conditions in terms of costs and demand [Salvatore 2007, p. 183]. Curve P is downward sloping and indicates all combinations of pric-es and the number of fi rms (N) operating in the market; as more fi rms enter the market competition becomes stiff er so the price charged decreases. Curve C is up-ward sloping and shows the relationship between the number of fi rms in industry functioning in a particular market and their average costs (AC); the more fi rms on the market, the lower their market shares, thus the higher AC. Points G and F show the initial market and cost conditions before market liberalization, while point E indicates the industry (market) long run equilibrium (Figure 1.4). Any

14 Th is is a simplifi ed causation scenario. In the actual conditions of the 2000s it was not only a positive quantitative supply shock. New technologies, higher stock of capital per worker and undervalued renminbi made the Chinese economy highly competitive.

form of opening the market (trade liberalization, entering the SEM or launching new long-term expenditure project) attracts newcomers from foreign countries and induces local fi rms operating in other sectors to seek new opportunities for expansion (shown as a downward shift of C to C'). Points E' and H indicate new markets and AC conditions aft er the industry (market) opening and the increase in the number of fi rms that entered the market (Figure 1.4).

Th e stylized relationships presented in Figure 1.4 are not very far from the EU specifi c hyper-competition [Polowczyk 2010] conditions, which New Member States have to face. Th e model in Figure 1.4 can be applied to analyze the specif-ic situation in the following three contexts: fi nal goods and servspecif-ices production, intermediary goods and services and also in the public procurement context.

Final goods and services producers undergo strong competitive pressure but they have more leeway in the management of their product portfolio and mar-gins as they may use creativity and innovations as their major tools of market success. Despite the shorter life cycle of products these producers can, using out-sourcing and off shoring policies, actively exert their superior position over their supply chain.

Intermediate goods and services producers depend on the ultimate purchas-ers of their output. Oft en, their market position is further weakened by purchaser Figure 1.4. Liberalization of entrance rules vs. competitive pressure

Source: adapted from: [Salvatore 2007]

Number of Firms (N) C

E

0

%

C'

P G E'

F H P, AC

oligopsony. Th eir very existence and economic condition depends on their costs and quality control culture and fl exibility. Being lower-case parts of global supply chains, the intermediate goods and services producers’ innovativeness had to be subordinated to the oligopsonic purchasers of their products. With the develop-ment in logistics and uniform technologies and low transportation costs they are constantly threatened by lower cost competitors.

Th e downward price mechanism shown in Figures 1.3 b and 1.4 applies to the sphere of open, pan-European public procurement tenders. Major infrastructural projects not only attract domestic fi rms already active on a specifi c market and other domestic companies that seek opportunities. Such big investments pro-jects pull in fi rms from other countries as well. Th us the number of fi rm com-peting for particular projects greatly rises pushing prices down (Figure 1.4). Th is mechanism is further magnifi ed by a single buyer (monopsony) – typical for ma-jor public infrastructural projects. Th is downward power is enhanced by specifi c regulations that were introduced in countries with a weak civil service qualifi -cations or such, where the level of public trust is low or are known for their bad corruption record (see Chapter 5). In this context, either through regulations or with the aim of avoiding accusations and responsibility, a system of a single cri-terion – the lowest bid price – became a rule. It might have both short and long term negative impact on the domestic industry.

In the short run, from the point of view of the purchaser it brings savings be-cause the competing companies are off ering prices much lower not only than their AC (see Figure 1.4) but also lower than the investor formal cost estimate (based on technical specifi cation and norms of the projects and typical costs of material and labor). Th e bidding fi rms bet on lower market prices of material, on possibilities to gain extra payments in the course of projects construction and on possibilities to further push down costs by subcontracting some of the work to local small and medium size companies.

In the middle and long run such predatory purchaser savings are virtual. Typi-cally projects carried out under such pressure are delayed and accompanied by le-gal action both in relations between purchaser and main contractor and between main contractor and subcontractors. Since law enforcement and law execution in new market economies is far from optimal (see Chapter 5), the resolution of legal disputes is time and money consuming. Th e parties to a dispute are not equal in terms of their fi nancial strength and thus have a highly diff erentiated ability to sustain, in fi nancial and economic terms procrastinated legal disputes. Th e mech-anism pushes domestic large and SMEs into a short-term self-defense policy of disregard to high quality and of avoiding big ambitious tasks and projects. Domes-tic and local fi rms do not develop their skills and specifi c competences because the mechanism does not reward high quality and innovative fi rms but only such that are able to compete in terms of costs. Th e destructive institutional and fi nan-cial environment leads to partial devastation of production capacity and a higher

petrifaction of sectoral structure at a regional level thwarting its development, increasing unemployment and forcing regional and international labor outfl ow.