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Knowledge-intensive intangibles, spatial transaction costs, and the rise of populism

  • Ram Mudambi
Commentary

Abstract

Populism is rising in many parts of the world and appears from both ends of the political spectrum. I identify two distinct global trends that underlie its rise. First, the rising knowledge-intensity of world output has turned the terms of trade against primary activities like agriculture and mining. Countries that have remained dependent on these activities have seen their economies stall. Second, falling spatial transaction costs have resulted in the rise of disaggregated global value chains, wherein low-knowledge activities have migrated away from high-income countries. This has led to a secular decline the standards of living of low-knowledge workers in these countries. The first trend is most pronounced in Latin America; here class-based leftist populist ire targets domestic elites that have insulated themselves, often through capital flight. The second trend is most visible in North America and Europe; here rightist populist anger is aimed at workers in (and immigrants from) poorer countries, who are seen as “stealing” low-knowledge jobs. Finally, I note that these economic explanations of rising populism are incomplete. In many quarters, the current form of globalization is seen as threatening national identity and this may be an even more powerful source of populism.

Keywords

populism high skill jobs innovation low skill workers offshoring globalization spatial transaction costs 

Introduction

Globalization at the simplest level has been defined as the increasing integration and interdependence of the world economy (Dunning & Lundan, 2008; Hill & Hult, 2016). The process of globalization has been going on, with fits and starts, since the beginning of the industrial revolution (Jones & Zeitlin, 2008). Globalization has faced strong opposition in the past, as when the landed aristocracy in England tried to maintain the protectionist Corn Laws (Fairlie, 1969). It underwent a decades-long reversal following the passage of the notorious Smoot–Hawley tariffs that are generally associated with deepening the Great Depression that culminated in the catastrophic Second World War (Irwin, 2011). Till relatively recently, it was widely believed that the terrible experiences of prolonged depression and war ensured that the forces of globalization in the post 1945 period were unstoppable (Helleiner, 1994).

Recent events from both the developed and developing world indicate that this view was over-optimistic. In this commentary, I shall offer an analysis based on international business and global value chains that complements Rodrik’s (2018) paper that is largely based on international trade theory. Taken together, the two analyses provide a fairly complete picture of the processes that have brought the global economy and polity to its current state.

The commentary is built on several interlocking logics. Examining the forces that supported the rise of globalization in the 19th and 20th centuries enables me to highlight the quantitative shifts that have undermined the relatively strong support for globalization in the post 1945 period. Comparing the current world economy of global value chains with the traditional Smith–Ricardo model of international trade allows me to demonstrate that the qualitative nature of trade has changed and eroded the pro-globalization coalitions of business, labor unions, and politicians in many countries. Finally, I argue that while the international economics and international business perspectives enable us to understand the economic effects of globalization, this is still a partial view of the rise of populism. In order to fully comprehend the phenomenon and see its true nature and extent, we must incorporate a more analytical view of boundaries, especially national boundaries.

Both the international economics and international business literature concur that the advantages of globalization accrue through arbitrage among countries. National borders represent discontinuities in geographic space; total factor productivity, national systems of innovation, and many other elements of business and economic systems are expressed at the country level. It is at this level that political decision-making is undertaken through governments and results in international business policy.

However, the national borders that define governments’ jurisdictions are not arbitrary lines drawn on physical geography. They are visible representations of underlying cultural and ethnic realities from which governments draw their legitimacy. For well over a century, the world economy has prospered when it has recognized national borders and been plunged into conflict when it has changed them against the will of the people. Taken together, the conclusion that emerges is unambiguous. Both economics and socio-cultural factors provide powerful arguments favoring the maintenance of the nation state as the prime unit of political organization within the global economy.

The Dissimilar Experiences of Latin America and East Asia: Rents vs. Profits

There is considerable evidence that the innovations associated with the industrial revolution spread fairly widely over Europe (Jacob, 1997). However, the application of these innovations in firms and the rise of industries occurred predominantly in Western Europe. These are the forces that led to the world order of the 20th century, wherein the countries in Western Europe embraced globalization and became dramatically wealthier, while those in Eastern Europe turned away from it and fell behind.

This difference has been traced to the nature of elites in these two sets of countries and the sources of their wealth (Acemoglu & Robinson, 2000). In the major countries of Western Europe, the power of the landed aristocracy had either been broken or was not particularly strong. In England, the power of the landed aristocracy had been severely curtailed by a growing and powerful central bureaucratic state (Brewer, 1988). In France, the landed aristocracy was virtually destroyed by the French Revolution of 1789. In these countries of Western Europe, the newly rising industrialists’ wealth stemmed from entrepreneurial profits based on innovative production processes and these were crucially dependent on trade. They were able to prevail over the landed aristocracy and push through free trade policies. The most famous example is perhaps the repeal in England of the Corn Laws in 1846 (Fairlie, 1969). The consequent economic growth in England and France led to their becoming the two richest countries in the world in the 19th century and their domination of the global economy through their respective empires (O’Brien & Keyder, 1978).

In contrast, the aristocrats of both Austria-Hungary and Russia, whose wealth stemmed largely from land rents, retained significant power throughout the 19th century. They were able to turn back challenges from their nascent industrial bourgeoisie and maintain the primacy of their landed estates and agriculture (Acemoglu & Robinson, 2000). These economies stagnated and they rapidly fell from prominence, ending the 19th century as marginal players in the global economy.

We see a corresponding picture of contrasting economic outcomes in the second half of the 20th century. Poor countries in East Asia, epitomized by South Korea (Amsden, 1989), pursued outward-oriented policies and witnessed rapidly rising incomes. Countries in Latin America, typified by Brazil, began in the mid 20th century as middle-income countries, but pursued inward-oriented policies and grew far more slowly, or even stagnated (Hannigan, Lee, & Mudambi, 2013). As in the case of 19th century Europe, one may trace the reason for these different policies to the nature of the respective national elites and the source of their wealth.

The wealth of Latin American elites stemmed mainly from primary sector exports (agriculture, ranching, mining, forestry), the traditional trading pattern for less developed countries (Prebisch, 1962). These returns mainly consisted of rent appropriation. Even when they did venture into industry, they focused on the domestic economy and generated returns through rent-seeking activities, i.e., import substitution based on monopoly rights and tariff protection (Hirschman, 1968). Consequently, Latin American elites saw little reason to pursue the innovation or local knowledge creation that would have been necessary to compete on world markets. High-quality, but technologically outmoded products could be imported cheaply from advanced countries or produced locally in screwdriver operations (Meyer, Mudambi, & Narula, 2011).

However, the countries of East Asia had very little in terms of arable land or natural resources, and hence could not enter international trade by exporting primary goods (e.g., Amsden, 1989). This disadvantage forced them to focus on the secondary (manufacturing) and tertiary (services) sectors. In so doing, they adopted elements of the development model pioneered almost a century earlier by Meiji Japan (Kojima, 2000). Beginning with heavy investments in education and infrastructure, they imported technology to develop export-oriented firms. This outward orientation and competition in global markets necessarily required their firms to acquire and implement the latest technologies. The elites’ wealth therefore arose from profit-seeking activities and required them to pursue and leverage knowledge and innovation.

Thus, the different development experiences of Asia vs. Latin America can be understood in terms of the differences in the orientations of the decision-making elites. The outward orientation of Asian (especially East Asian) countries based on innovation catch-up (Awate, Larsen, & Mudambi, 2012) led to the rise of globally competitive emerging market MNEs (EMNEs) like Samsung (Korea), Huawei (China), and many others. The inward orientation of the Latin American countries was based on subsidizing globally uncompetitive domestic industries out of the proceeds of primary goods exports managed by relatively inefficient government firms like Petrobras (Brazil) and YPF (Argentina).

In summary, the rent-based economies of Latin America lacked internal incentives to invest the surpluses from their primary sectors into the development of a knowledge infrastructure that would have propelled them out of what has been termed the “middle-income trap” (Lee, 2013). The difference between the Asian and Latin American experiences may be seen as a manifestation of Dutch disease and the “natural resource curse”: the apparent paradox whereby countries that possess significant quantities of natural resources are actually hampered in their attempts to achieve economic advancement (Auty, 2001; Sachs & Warner, 2001). The primary sector initially attracts the best resources away from the more dynamic secondary and tertiary sectors (Dutch disease). Subsequently, as the terms of trade turn against the primary sector, its primacy in the economy allows it to maintain a stranglehold on policy even as its prospects deteriorate (the natural resource curse).

Local Value Chains in North America and Europe: Geography-Based Incomes

The costs of conducting business transactions across geographic space have been falling continuously, at least since the beginning of the industrial revolution (Hill & Hult, 2016). However, through the mid-twentieth century, this decrease was slow enough that value chains remained largely local, i.e., concentrated in particular locations or at most, within country borders. In the 1950s, the Detroit automobile cluster drew on a predominantly local supplier network within the industrial Midwest of the U.S. (Klier & McMillen, 2008), most of the filmed entertainment cluster was located within a small radius in and around Hollywood (Scott, 2005), and the San Francisco naval shipbuilding cluster had a significant effect on its host city, employing a large labor force of all levels of skill (Walters, 2000). Similar patterns have been documented for several industries in Europe such as German machinery (Gertler, 1996), Norwegian furniture (Isaksen, 1997) and Swedish aerospace (Brown, 2000). All over the industrialized world, value chains were mostly rooted in local geographic space.

Further, the knowledge-intensity of the global economy has been rising and throughout the 20th century, most of this increase stemmed from industrialized countries (King, 2004) and created significant increases in national income. Much of this knowledge was created and deployed in industrial clusters that became the economic engines of their host countries and the creators of national comparative advantage (Porter, 2000). As I will argue in succeeding sections, the value created in these industrial clusters was mainly the product of workers with high knowledge or high skill. However, to leverage this cluster knowledge firms used local low-skill labor. The workers’ main advantage was their geographic location, as high spatial transaction costs insulated local labor markets from foreign competition. While they gained experience and knowledge over time, these (largely unionized) low-skill workers were generally able to demand and obtain wages disproportionate to their levels of human capital (Ferguson & Galbraith, 1998). In a very real sense, the relatively low wage inequality in advanced economies in the first two-thirds of the twentieth century was the result of low-skill labor free-riding on the value created by high-knowledge and high-skill labor.

Hence, the post-World War 2 period saw an alignment of local, national, and corporate interests in most industrialized countries (Mudambi, 2013). Corporations and labor (especially low-skill labor) needed each other to take advantage of the knowledge-based assets that were being created in the local innovation system. Corporations employed the full range of local labor and acceded to the (mostly union-led) bargaining power of low-skill workers by paying them disproportionately more than their marginal productivity. They financed this by paying local high-skill workers less than their marginal productivity, and this effective wealth transfer created both relatively low income inequality as well as an affluent middle class.

“Americans achieved consensus by celebrating a supposedly impartial efficiency and productivity” (Maier, 1977: 607) and their commonality of interest drove the political system toward the center. In Western Europe, all groups within the nation state recognized their interdependence and that they had much “to gain from solidarity, losing in its absence” (Baldwin, 1990: 35). While there was still bargaining about the apportionment of value between capital and labor, growing local value creation ensured that most voters were both middle class and centrist and the resulting political battles were between candidates sited at the center-right and the center-left.

This world, that saw its heyday in the late 1950s through much of the 1980s, formed a worldview that still resonates with most voters in industrialized countries. It is a view that takes for granted the correlation between incomes on the one hand and geography on the other. In this perception of the world, it is taken for granted that an assembly line worker in Detroit or Lyons should enjoy a lifestyle far superior to that of a brain surgeon in Mumbai or Bangkok. Very few recognize the root cause of this reality – the high spatial transaction costs that insulate national labor markets from one another. It was inevitable that declining spatial transaction costs would cause this reality to crumble.

Knowledge-Based Intangibles and Spatial Transaction Costs

There are two global trends that are relevant to this paper. The first concerns the changing source of value in the global economy and the second concerns the organization of global production. Both of these long-terms trends can be traced to the disruptive force of innovation.

The first global trend is the migration of global value creation to knowledge-based intangibles (Mudambi, 2008). This trend implies that the terms of trade have been shifting inexorably in favor of innovation-based services and against primary sectors. In other words, the outward-oriented, innovation-driven strategy of the Asian countries has been in sync with these global trends, whereas the Latin American countries’ inward-oriented, protectionist strategy ran precisely counter to them (Wood, 1997). Not surprisingly, Asian economies boomed, while Latin American economies stagnated (see Figure 1). In short, the terms of trade turned against the Latin American countries, driving down rents and increasing their volatility. Internally, this resulted in reduced returns to unskilled labor. This occurred directly through cuts in real wages, indirectly through a decrease in the subsidization of necessities, or both.
Figure 1

East Asia vs. Latin America: performance of selected economies

The second global trend is the precipitous decrease in spatial transaction costs that began in the late 20th century. Some even dubbed it the “death of distance” (Cairncross, 1997) and it led to the geographic disaggregation of global value chains. The first wave of this change appeared in the form of offshoring, i.e., of the movement of low-skill activities to emerging market economies (Grossman & Rossi-Hansberg, 2008; Mudambi, 2008). However, in the decades of the 21st century, it has continued in the form of activity rationalization, wherein MNEs based in both advanced and emerging market economies fine slice their global value chains and locate the constituent activities in the most appropriate locations. Not surprisingly, high-knowledge activities tend to be concentrated in global knowledge hotspots, most of which are still located in advanced countries. Low-knowledge activities have largely migrated to emerging and poor countries.

The Economic Drivers of Populism

The above analysis of global trends provides a basis for understanding the rise of populism from an international business perspective. Deteriorating terms of trade are the basis of populism in Latin America, whereas the disaggregation of global value chains is the source of populism in Europe and North America. While these two forces are related, they have had different effects in the two groups of countries.

In Latin America, the burden of worsening terms of trade fell mainly on the poor, worsening income inequality that was already quite high. Discontent was muted when these economies were growing, but flared up once they flatlined (see Figure 1). The targets of discontent were primarily local elites who were perceived to have preserved their rents at the expense of the populous working class. Driven by social class, this populism was naturally left wing and developed in separate variants within each national context.

In Europe and North America, low-skill jobs moved to emerging and poor countries. As pointed out by Rodrik (2018), in Europe, there was the added factor of a sudden increase in immigration into societies that had little familiarity with it. Hence the targets of discontent were foreign workers, who were perceived to undercut what rich country workers believed to be the income and lifestyle that they deserved. This populism took on a nationalist, and often xenophobic tone and was naturally right wing. Hence the two different drivers – terms of trade and global value chain disaggregation – have fueled the leftist and rightist versions of populism that have arisen in these two contexts.

As argued by Rodrik (2018), international trade has been associated with rising populism many times over the last century and a half, often with tragic consequences. However, in addition to the excellent points he makes, there is the issue that the “crowds in the streets” are fundamentally different. In Europe and North America, these people are largely middle class; many are low-skill workers whose standards of living have collapsed as global value chains have disaggregated across national borders in response to falling spatial transaction costs (Table 1). In contrast, in Latin America, the mass of the people are the poor who have been hard hit by the withdrawal of subsidies as their governments’ finances have grown more straitened. Foreign MNEs have escaped becoming the main object of the resulting unrest because they often provide a significant number of high-paying jobs. However, as Rodrik (2018) points out, the local elites have never enjoyed a particularly warm relationship with the poor masses. Their ownership of many of the primary industries (e.g., mining and agriculture) whose fortunes have been declining in the current knowledge economy has made them easy targets for left-wing populist politicians.
Table 1

Wages for high-knowledge and low-knowledge labor in Michigan, U.S. 1976–2016

 

Annual wages

2016 real wages**

Percent change, 1976–2016

1976

2016

Michigan production workers

$8,786*

$28,940

$6,727

−30.61%

Michigan mechanical engineers

$14,254

$88,700

$20,618

+30.87%

Knowledge markup***

62.24%

206.50%

206.50%

231.78%

Source: U.S. Bureau of the Census, (1976); U.S. Bureau of Labor Statistics, 2016.

*Excluding overtime.

**2016 wages in 1976 U.S. dollars.

***The percentage markup of mechanical engineers’ wages over production workers’ wages.

By way of contrast, the same global trends provide us with the means to understand the (relative) lack of globalization-induced populism in East and South Asia. A glance at World Bank data is enough to see that these countries (South Korea, Taiwan, Singapore, Malaysia, followed by China, India, Indonesia, and more recently, Vietnam, among others) began as far poorer than Latin American countries in the middle of the 20th century. Most of these countries did not have significant surpluses of natural resources, and were relatively unaffected as the terms of trade turned against these commodities. Whether or not their increasingly sophisticated roles in disaggregated GVCs were reflective of advanced country status (Baldwin, 2011), the process lifted literally millions of their poor citizens into the middle class (e.g., Amsden, 1989). Not surprisingly, the current wave of globalization receives its strongest support in these countries (Pew Research Center, 2014).

Concluding Remarks: Nations as Ethnic and Cultural Constructs

Populism is defined in the dictionary as a political philosophy that supports the rights of the common people. It has typically been associated with the victory of emotion over analysis, prejudice over reason, and demagoguery over oratory. It thrives by deepening and exacerbating social divisions. There are indeed two relevant societal schisms – “an ethno-national/cultural cleavage and an income/social class cleavage” (Rodrik, 2018) – underlying the current global populist wave. These two differ in terms of who they identify as the “other” relative to the common people of the nation. Rightist populism arises from the ethno-national schism when the “other” is perceived to be the foreigner, using the lens of the nation like Heidegger’s volk (Phillips, 2005). Whereas Leftist populism arises from the schism of social class when the “other” is believed to be the domestic plutocrat, taking advantage of forces that stem from abroad.

There is truth to the view that populism is to a large extent “guided by those mysterious forces which the ancients denominated destiny, nature, or providence” (Le Bon, 1896, p. ix). However, beneath the apparently illogical and often contradictory froth of populist discourse, there are fundamental human motivations. Schisms, after all, arise from boundaries. Thus, we can develop a better understanding of these two schisms if we analyze them using a formal boundary spanning approach. Not surprisingly, this literature draws on the two disciplines most concerned with human motivation: economics (like Rodrik, 2018) and sociology. Populism is the product of angst: it is rooted in both economic considerations of income and standard of living and also in sociological considerations of belonging and identity (Schotter, Mudambi, Doz, & Gaur, 2017).

The modern economics perspective is considerably more sophisticated than the homo economicus postulate of selfish wealth-maximization that persisted through the middle of the 20th century. However, it still views human happiness (often summarized using the shorthand of “utility”) as the outcome of material well-being, and human behavior as being driven by it. While individuals may make systematic errors, as documented by behavioral economics, their pursuit of utility is unquestioned. There is no doubt that this perspective explains much of human behavior. But limiting oneself to the economics perspective presents an incomplete picture of human behavior.

In contrast, the homo sociologicus postulate specifies that human actors are so interdependent that social structure dictates individual behavior, perception, and motivation. As a result, individuals follow prevailing social norms more or less blindly and with little regard for individual self-interest (Ng & Tseng, 2008). Accordingly, collective identity coordinates and harmonizes individual actions by replacing individual goals and perceptions with collective ones (Durkheim, 1938; Ouchi, 1980). The embeddedness view that softens this extreme position, is that individuals are embedded in and shaped by concrete, ongoing systems of social relationships without being completely controlled by those relationships and the accompanying norms and roles (Granovetter, 1985).

Only by integrating the economics and sociology perspectives can we develop a complete picture of the effects of globalization, one that incorporates the effects of both individual material well-being as well as group identity.

Proponents of globalization have been overly influenced, consciously or unconsciously, by the economics perspective of individual material well-being. This includes the bulk of international economists and the mainstream international business literature is not very different (Mudambi, 1998). They have a negative view of boundaries: income class boundaries are symptomatic of inequality and national borders are barriers or dividers that impede wealth-creating globalization. Hence, lowering or erasing boundaries is generally considered a good thing.

They are often puzzled when presented with evidence that individuals or groups oppose globalization independently of whether or not it affects them economically (Brader, Valentino, & Suhay, 2008). But this is because the economics-centric view, while partially true, is overly simplistic. By ignoring the effects of identity, it fails to incorporate the full range of human motivations.

Boundaries serve two functions – they divide the world into “us” and “them,” but in doing so, they also identify “us.” In other words, boundaries provide identity. During the halcyon days of what has come to be called the Washington Consensus, high spatial transaction costs reinforced national boundaries to insulate labor markets, decoupling wages from productivity and compressing the domestic wage distribution. In so doing, they penalized high-knowledge workers, both in advanced market economies and even more so in poor countries. Identity based on income may be undesirable, i.e., it is unlikely that many would prefer to remain poor when offered the opportunity to accede to the middle class. However, identity at the level of nation state is a different matter altogether. When globalization tears down or diminishes national boundaries, it threatens the ethno-cultural group identity of a people.

So addressing the economic effects of globalization cannot by itself address the rising tide of populism. Evidence of this may be seen in the experiences of countries like Denmark, where the gains of globalization have been distributed fairly evenly through retraining, upskilling, and re-skilling, so that there are relatively few economic losers (Daemmrich & Kramarz, 2012). However, this has not prevented growing right-wing populism: it is rooted in an opposition to immigration, a phenomenon that directly threatens national identity, especially in a country with a small, homogeneous population (Green-Pedersen & Odmalm, 2008). This opposition often carries over with particular virulence to skilled immigration, which provides domestic low-knowledge workers with a clearly defined scapegoat to blame for their falling living standards.

Clearly, many countries in the world have gained enormously from immigration. In North America, many of the most innovative entrepreneurs from Andrew Carnegie to Elon Musk have been immigrants. Both North America and Western Europe are dependent on inflows of high-knowledge human capital, much of it from Asia. These so-called Argonauts (Saxenian, 2007) do everything from running high technology industries to teaching and conducting research in universities. The current populist wave has cast a shadow over the migration of high-knowledge individuals that many argue has the potential to cripple the currently wealthy economies for years to come (Wadhwa, 2012). Hence, any policy solutions to address threats to national identity must be nuanced, recognizing that a blanket curtailment of immigrant flows would be disastrous for the rich host economies. It is likely that such policy solutions will require international cooperation to govern immigration flows in a manner that shores up the role of the nation state and thus allays concerns that national identity is being watered down.

In conclusion, while I may argue that Rodrik’s (2018) analysis is incomplete, I nonetheless reach the identical conclusion. I wholeheartedly endorse him when he says that “we must understand that the best contribution global arrangements can make is to make the nation state work better, not to weaken or constrain it” (Rodrik, 2018). It is worth re-emphasizing that visible arrangements like national borders, customs agents, and the physical contraptions dividing one nation from another are merely representations of underlying ethnic and cultural identities (Beugelsdijk & Mudambi, 2013; Schotter et al., 2017). Those on each side of the border share these group identities with one another. If globalization threatens these identities, it threatens something deep and primal within each of us and the reaction is bound to be undesirable. However, if its impact on national identity is seen to be benign, its enormous potential for wealth creation can take the world into an ever more prosperous future.

Notes

  1. 1

    Between the 1976 and 2016, the wage premium for high-knowledge workers in the U.S. state of Michigan more than tripled from 62% to over 206% (see Table 1).

     
  2. 2

    The future is even bleaker. For instance, the U.S. Bureau of Labor Statistics (2016) forecasts that the employment of assembly line workers in Michigan will decline a further 14% between 2016 and 2026.

     
  3. 3

    I am grateful to my colleague T.L. Hill for our long discussions about integrating homo economicus and homo sociologicus to build a more complete model of human motivation.

     
  4. 4

    It is not surprising that the awakened populist fervor around ethno-cultural identities provoked by globalization, has stirred schisms at the subnational level as well. Thus, the Scots, the Walloons, the Flemish, the Catalans, and many others, may begin to emphasize their subnational rather than national identities. Threatening identity unleashes a Pandora’s Box of destabilizing forces.

     

Notes

Acknowledgements

I would like thank the editors, Sarianna Lundan and Ari van Assche, for perceptive comments that significantly improved the paper. Stanley Ridgley gave me a number of key insights that helped me better ground my arguments in the history of political philosophy. Years of discussions with T.L. Hill have informed several of the points made in this manuscript. Finally, I was really motivated to turn my oral commentary into a written one by the encouragement of leading scholars like Ruth Aguilera, Ari Lewin, Alain Verbeke, and many others.

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Copyright information

© Academy of International Business 2018

Authors and Affiliations

  1. 1.Fox School of BusinessTemple UniversityPhiladelphiaUSA

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