The End of Globalization?

Multinational corporations are more vulnerable than you think

| July/August 2002 Issue

Globalization, argues New York Times columnist Tom Friedman, is "making it possible for . . . corporations to reach farther, faster, cheaper, and deeper around the world" and is fostering "a flowering of both wealth and technological innovation the likes of which the world has never before seen." To David Korten, a former Ford Foundation official and now a prominent globalization critic, it is "market tyranny . . . extending its reach across the planet like a cancer, colonizing ever more of the planet’s living spaces, destroying livelihoods, displacing people, rendering democratic institutions impotent, and feeding on life in an insatiable quest for money." The careful listener to this by-now-familiar debate can actually discern a striking point of agreement: Both sides assume, one with euphoria and the other with fear, that global-scale business is the wave of the future. Yet there’s mounting evidence that multinational firms may be less capable of delivering competitive products than national or local firms. AT&T stunned financial analysts in October 2000 when it announced that it was carving itself up into four, more versatile, companies. In May 2001, British Telecom unveiled a plan to spin off its wholesale arm, part of its wireless business, and numerous assets in Asia. Other self-initiated split-ups and slim-downs seem likely to follow. These developments are important reminders of a point all but forgotten in the globalization debate: Scale matters. Any first-year economics student learns that firms can lower average costs by expanding, but only up to a point. Beyond that point (according to the law of diminishing returns to scale), complexities, breakdowns, and inefficiencies begin to drive average costs back up. The collapse of massive state-owned enterprises in the old Soviet Union and the bankruptcies of Chrysler and New York City are notable reminders of a lesson we should have absorbed from the dinosaur: Bigger is not always better. A telling example in economic life is commercial banking. Despite all the headlines about mergers, researchers at the Federal Reserve in Minneapolis have concluded that "after banks reach a fairly modest size [about $100 million in assets], there is no cost advantage to further expansion. Some evidence even suggests diseconomies of scale for very large banks." The Financial Markets Center, a financial research and education organization, has found that, compared to banks with far-flung portfolios, those that concentrate lending in a geographic region were typically twice as profitable and wind up with fewer bad loans. While the press has diligently reported national and global mergers, it has largely ignored the recent proliferation of community banks, credit unions, and microloan funds. Banking, it turns out, is not the only exception to the rules of globalization. Five factors are playng a significant role in shrinking the economies of scale for a wide range of industries. 1. First, it turns out that global-scale industry is surprisingly inefficient at distribution. In 1910, for every dollar Americans spent for food, 50 cents went to farmers and 50 cents to marketers and providers of inputs like seeds, energy, and fertilizer; now 9 cents goes to farmers, 24 cents to input providers, and 67 cents to marketers. The marketers’ 67 cents are largely unrelated to the end product that consumers really want. They’re wasted on packaging, refrigeration, spoilage, advertising, trucking, supermarket fees, and middlemen. When farmers can link more directly with nearby consumers, they can cut out these inefficiencies. This explains the spread of community-supported agriculture (CSA), pioneered initially in Japan and then Switzerland, now growing by leaps and bounds across North America. It works like this: A farmer is supported by 60 or 70 households, each of which pays a fee to receive a weekly supply of vegetables. More than 600 community-supported agricultural or horticultural operations now operate in 42 states, with 100,000 members. 2. A second factor exacerbating the inefficiency of global-scale distribution is the rising cost of shipping. In the past two years the per-barrel price of oil has quadrupled. And with expected increases in global population and per capita consumption, the U.S. Energy Information Administration projects that demand for oil worldwide will grow by 20 million barrels a day, a third more than current consumption levels. Improving technologies for petroleum recovery may ease upward pressures on oil prices a bit. But political pressures, including attempts to levy "green taxes" and political instability in oil regions like the Middle East and Central Asia could drive up prices. Until other fuels are substituted for oil, global shipping probably will become more expensive. 3. A third challenge facing global businesses is the difficulty of managing information. Conservative economist Friedrich Hayek once argued convincingly against state socialism by noting that knowledge is too complex, too subjective, and too dependent on particular circumstances of time and place for even the best-intentioned national-scale bureaucracies to grasp it. The exact same problem afflicts multinational corporations. In principle, a global producer can wield its resources to produce different products for different local tastes. But in practice, a local producer is better situated to intuit, design, manufacture flexibly, and deliver just-in-time products. Consumers can better communicate their needs to local producers, either directly or through local retailers. General Foods probably will never be able to convince New Yorkers to replace their locally baked bagels with Minnesota-made generics. Microbrewers have flourished throughout the United States and the United Kingdom because each of them caters to highly specialized tastes. The desires of Bay Area food shoppers wanting more varieties of locally grown fruits and vegetables, have expanded the region’s agricultural economy by 61 percent over the past decade, which translates into $915 million of additional agricultural income in the local economy each year. 4. A fourth trend is the transformation of the U.S. economy from manufacturing goods to providing services. The main reason for this shift, according to MIT’s Paul Krugman and Harvard’s Robert Lawrence, is that technological advances have brought down the prices of many manufactured goods. As Americans spend less to acquire the same refrigerators and toasters, they spend more on services. These changes, Krugman argues in Pop Internationalism (MIT Press, 1997), are moving the U.S. economy inexorably toward what he calls localization: "A steadily rising share of the workforce produces services that are sold only within that same metropolitan area." For most services—whether it is health care, teaching, legal representation, accounting, or massage—consumers demand a personal, trusting relationship. 5. A fifth difficulty facing large-scale business is the information revolution. Global corporations are still amassing huge networks of factories, technology centers, and experts at a time when profitability is increasingly uncoupled from size. Small companies can now fit what used to be busy departments overseeing accounting, management, taxes, communications, and publications neatly onto a desktop computer. The Internet has given even home-based businesses the ability to compete against established, large-scale players in practically everything, including books and CDs, stocks and bonds, airline travel, and hotel rooms. Even for industries like automobiles, where large economies of scale still make sense, the communications revolution is making it possible for small firms to achieve the same advantages through collaborations and partnerships. In northern Italy, locally owned firms involved in flexible manufacturing networks have become world-class exporters of high-tech products like robotic arms. A network typically forms temporarily to create a specific project for a well-defined niche market. Once the project is complete, the network disbands. Following successful models in Europe, more than 50 flexible manufacturing networks have been set up in the United States. These five trends do not mean that all goods and services can be produced cost-effectively in every community. (The economics of any company or industry depend on how the new diseconomies of large scale balance against the old economies of scale.) At a minimum, however, they suggest that much of the hype from globalization’s fans—and its enemies too—is overblown. If smaller businesses wind up being the most efficient producers and suppliers of many goods and services to nearby markets, then neither the utopian nor the nightmare scenarios of globalization will come to pass. Indeed, global trade may simply become a relatively minor part of most economies, as it is for ours right now (exports are responsible for less than 10 percent of our national income)—provided, of course, that politicians resist the temptation to bail out global businesses doomed by inappropriate scale. The next wave of economic development—local, national, and global—may turn not on the rise or fall of any grand concepts like globalization, but on the slow, steady creation of appropriately scaled businesses. As the poet Wendell Berry once remarked, "The real work of planet-saving will be small, humble, and humbling. . . . Its jobs will be too many to count, too many to report, too many to be publicly noticed or rewarded, too small to make anyone rich or famous."

Michael H. Shuman, an attorney and economist, is co-director of the Institute for Economics and Entrepreneurship for the Village Foundation, a Washington, D.C.