The True State of Globalization
The July-August issue of the Harvard Business Review features an article by NYU and IESE professor Pankaj Ghemawat, - Globalization in the Age of Trump: Protectionism Will Change How Companies Do Business - But Not in the Ways You Think. Ghemawat has long been conducting research on globalization, and has written extensively on the subject. His latest book, The Laws of Globalization, was published in October of 2016.
“Business leaders are scrambling to adjust to a world few imagined possible just a year ago,” notes the article’s opening sentence. “The myth of a borderless world has come crashing down. Traditional pillars of open markets - the United States and the UK - are wobbling, and China is positioning itself as globalization’s staunchest defender. In June 2016, the Brexit vote stunned the European Union, and the news coverage about globalization turned increasingly negative in the U.S. as the presidential election campaign progressed.”
What should companies do? Should they pack up and return home? Is this the end of globalization, only a dozen years after Thomas Friedman’s The World is Flat became a prominent international best-seller? “Not according to my research,” says Ghemawat.
First of all, the claims of a flat world unconstrained by borders, distance and culture have been greatly exaggerated. He coined the term globaloney - the tendency to overestimate the intensity of international business activity compared to local activity, and to underestimate the constraints imposed by distance and cultural differences. Today’s talk about The retreat of the global company, as The Economist put it in a recent issue, represents an overreaction in the opposite direction. “While some of the euphoria about globalization has shifted to gloom, especially in the United States, globalization has yet to experience a serious reversal.”
Ghemawat is co-author of the biennial DHL Global Connectedness Index, a detailed analysis of the state of globalization around the world. Its most recent report, released in November, 2016, “shows that global connectedness, measured by cross-border flows of trade, capital, information and people, surpassed its 2007 pre-crisis peak during 2014. In 2015, globalization's post-crisis expansion slowed, but the data indicate that it did not go into reverse. Currently available evidence… suggests that the world was about 8% more connected in 2015 than in 2005.” Information flows, - measured by international internet traffic, telephone call minutes and trade in printed publications - has grown over 60% over this ten year period.
Just because globalization has not gone into reverse, doesn’t mean that everything is OK. The US, UK and much of continental Europe are convulsed by a generalized, deep-felt anger against globalization whose political implications are hard to predict. Protectionist pressures could lead to tariffs and trade wars. Few are advocating that companies react by pulling back and going home. But, it’s a good time for companies to reevaluate their globalization strategy, including where and how to do business around the world.
According to Ghemawat, a globalization strategy should be based on three interrelated options: adaptation, aggregation, and arbitrage.
Adaptation means responding to differences among countries by tailoring products and services to suit local tastes and needs. However, each such local variation adds costs and complexity, thus reducing the benefits of aggregation and economies of scale. Smart adaptation requires limiting the amount of local variations as well as finding the most efficient ways of introducing such variations. Platforms offer a good way forward, offering the aggregation benefits of a common platform foundation, while each country or region can develop its own ecosystem of platform partners, whose product and services are adapted to local requirements.
Aggregation is used to deliver economics of scale and scope by expanding operations across national borders. Aggregation drives efficiencies and productivity and is one of the most common justification for having a global R&D, manufacturing and logistics strategy. “Those advantages normally have to be pretty large in order to overcome the home court advantage of local competitors… Companies that have operations in markets where they’re only marginally successful, on the other hand, may need to retrench.”
Arbitrage leverages economic differences between national and regional markets, such as labor costs and tax incentives. Arbitrage opportunities have somewhat narrowed in recent years, given the rising prosperity of several emerging markets. Even then, US GDP per capita is seven times that of China and 33 times that of India, - let alone those of poorer countries in Asia and Africa, - so labor arbitrage isn’t likely to disappear in the foreseeable future. Neither will tax arbitrage, given the large differences in tax regimes across countries, and the slow progress in curbing tax havens. “Furthermore, cross-country differences in safety, health, and environmental standards continue to persist as well - although exploitation of these differences raises ethical concerns.”
The article offers pragmatic advice to help global companies continue to enjoy the benefits of adaptation, aggregation and arbitrage while being responsive to rising protectionist pressures.
Companies should consider regional strategies, as a reasonable compromise between a one-size-fits-all global strategy that ignores local differences, and an inefficient and costly highly localized strategy. Such strategies would allow them to take advantage of similarities between neighboring countries in the same region. “An analysis of 29 distance variables shows that in almost all cases countries from the same region average higher similarity scores than countries from different regions - and often by very wide margins.” Another pragmatic such variant is to localize the customer-facing, front end parts of the strategy, while centralizing the back-end platforms that support R&D, production and other operational functions.
The article points out that “the backlash against globalization is also, in part, a backlash against big business. The general reputation of business is at an all-time low. Multinational companies need to craft governmental and societal agendas that are both localized and linked across countries. Anti-globalization pressures require that multinationals deliver more local benefits - and communicate about them - in the countries where they operate. Such efforts must go well beyond compliance to include contributions in the form of jobs, technology, and so forth.”
In that article, Palmisano presciently warned that “The alternative to global integration is not appealing. Left unaddressed, discontent with globalization will only grow. People might ultimately choose to elect governments that impose strict regulations on trade or labor, perhaps of a highly protectionist sort. Worse, they might gravitate toward more extreme forms of nationalism, xenophobia, and antimodernism,” raising issues “that are too big and too interconnected for business alone or government alone to solve.”
In October, 2016, Palmisano published a follow-up to his 2006 Foreign Affairs article, - The Global Enterprise: Where to Now?. His decade-old warning has come true. “Today, the world stands at the crossroads described in that article… A rising chorus of nationalism echoes across developed countries; it calls for tighter borders and restrictions on immigration. Global trade negotiations have essentially ceased, and regional trade deals face strong headwinds of opposition… Although political forces seem to be trying to separate people, technology is digitally connecting and integrating them in everything from business to entertainment to commerce to social sharing and commentary to scientific endeavors.”
What went wrong? Part of the problem is that global firms have generally responded to this challenging economic environment by focusing primarily on reducing their overall operational costs. Despite dramatic advances in technology, companies have mostly ignored the opportunities to pursue growth through innovative new products and markets.
“What’s clear is that the opportunities for companies are going to be massive over the next ten years. But the competitive pressures are going to be greater, and the price of failure will be higher…” wrote Palmisano in conclusion. “The key now is for enlightened leaders to develop and continually modernize models for business and government. If they don’t, we will see an increase in intolerance and tensions. If they do, I’m confident that the challenges of today and tomorrow can be overcome in ways that deliver greater civility, more employment, higher incomes, and greater prosperity for people throughout the world.”