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Introduction to Globalization

Introduction to Globalization

What you’ll learn to do: explain why nations and U.S. firms engage in global business

Spice Route. Salt Road. Trans-Saharan Trade Route. Trade has been an aspect of the human experience for literally thousands of years, with merchants hazarding mountains, rivers, deserts, and seas to obtain rare commodities. However, the environment of pre-21st century traders is significantly different than our current business environment.

In this section, we will draw a distinction between international trade and globalization and discuss the implications for businesses, workers, and societies. We will also introduce the concepts of comparative and absolute advantage and illustrate how these concepts relate to opportunity cost that serve as the basis for making specialization and trade decisions. We’ll conclude with a video and interactive exercise that reinforces learning and the relationship between international trade, productivity, and standards of living—be it on Gilligan’s Island or in the real world.

1. Globalization

decorative imageThere was a time when consumers only had access to goods and services that were available locally. Their choices were limited by what they could access on foot, by horse, or by carriage. This is still the case for many people around the world, and in rural and remote parts of the U.S., it’s still necessary for families to make weekly trips to town to stock up on food, household items, and other necessities. However, with the rise of Internet-based business (think Amazon), there’s been an explosion of international trade, and more and more consumers essentially have the world at their door. Of course international trade isn’t just a twentieth-century phenomenon. Trade across borders and between cultures has been a feature of human civilization for centuries—there’s evidence of this dating back as far as the 19th century BCE. The Silk Road, one of the best-known and most enduring “international” trade routes, began sometime around 200 BCE and for centuries was central to cultural interaction from China through regions of the Asian continent all the way to the Mediterranean Sea.

So, if cultures and nations have been trading with one other for four thousand years, what makes today’s business landscape different? The answer lies in the distinction between international business and globalization.

International business refers to commerce in which goods, services, or resources cross the borders of two or more nations. This is what the Egyptians were doing when they sent goods across the Red Sea to Assyria. Globalization is broader than international business and describes a shift toward a more integrated world economy in which culture, ideas, and beliefs are exchanged in addition to goods, services, and resources. Globalization implies that the world is “getting smaller”: As a result of new transportation and communication technologies, people around the world can more readily connect with one another—both virtually and geographically.

The following video provides a good introduction to the causes and consequences of globalization.

You can view the transcript for “Globalization easily explained” (opens in new window) or the text alternative for “Globalization easily explained” (opens in new window).

Impact of Globalization on Global Business

The video above provides a good bird’s eye view of the effect of globalization on business—from opening up new markets to increasing the level of competition within markets and industries. Let’s take a look at particular example, though, to think through the various implications of conducting business on a global scale. Consider McDonald’s, which was started by two brothers in San Bernardino, California, 68 years ago. As a result of globalization, nearly 69 million people in 118 different countries eat at McDonald’s every day. The first McDonald’s outside the U.S. and Canada was established in Costa Rica in 1970, and since the 1990s, most of the company’s growth has taken place in foreign countries. The process of building a global presence, entering new markets, and capitalizing on growing international demand for American fast food has enabled McDonald’s to expand from a single location to a global corporation with over 37,000 locations in over 100 countries.[1] However, entering new markets—whether at home or abroad—means contending with increased competition in those markets, including competition with other globally minded companies. In 2010, Subway surpassed McDonald’s to become the largest single-brand restaurant chain and the largest restaurant operator globally (although, since 2014, Subways’ sales have lagged behind McDonald’s).[2]

What is it like for companies that decide to take advantage of global opportunities, as McDonald’s and Subway have? Return to the discussion of “external forces” in Module 1, but now consider them from a global business perspective. Globalization certainly means that businesses can reach consumers around the world more rapidly and efficiently—thanks to cell phones, airplanes, and the Internet, we are all so much more interconnected and “accessible” now. But globalization also means incredible complexity.

MCDONALD’S IN THE GLOBAL BUSINESS ENVIRONMENT

The list below sketches out just a few of the complexities and challenges that an American fast-food company like McDonald’s faces when it takes on the global business environment.

The Global Economic Environment

McDonald’s is a corporation based in the United States, where all business transactions are conducted using the U.S. dollar, but there are 164 official national currencies in the world, each with a different value and purchasing power. Imagine trying to balance the corporate checkbook at McDonald’s when your deposits have been made in more than a hundred different currencies.

In 2012, Greece established a municipal ordinance banning eating food at certain historic, artistic, and culturally important sites, and fines can reach up to $650. If you are the operator of a McDonald’s near the Parthenon, should you remove the ice cream cones and McFlurries (and other easily portable food) from your menu to protect your customers against being fined, or not?

The Global Competitive Environment

How does McDonald’s recapture the number-one position it lost to Subway in 2010? The company may need to make substantial changes to its operations, menu offerings, and/or marketing tactics. This is a steep, uphill climb in the United States alone, but consider trying to accomplish it in 118 different countries in 188 different markets—where you are competing not only with other global U.S. fast food companies, like Subway and KFC, but with local ones, like “McKebab,” as well!

McKebab, a fast-food restaurant in Slovakia whose name and golden "M" resemble a McDonald's restaurant.

The Global Technological Environment

What does technology have to do with fast food or McDonald’s? Consider the company’s presence in China, where there are nearly 1.3 billion mobile users, and say hello to “McDonald’s Next,” a “modern and progressive” version of the restaurant that first opened in Hong Kong in 2017, featuring mobile-phone-charging platforms, free Wi-Fi, and self-ordering kiosks. This next generation of McDonald’s is a response to increased expectations around speed, service, economy, and availability across established and developing economies, mostly fueled by consumers’ growing access to affordable technology. As global businesses respond to demands created by technology, they must also leverage technology to move products, people, and supplies around the globe in a cost-effective and efficient manner.

The Global Social Environment

McDonald’s has had to adapt in countless ways to meet the demands of its customers around the world. While it prides itself on offering a consistent, internationally recognizable menu and brand, the company has also had to cater to local dining preferences and customs. In 1995, for example, the first kosher McDonald’s opened in a Jerusalem suburb. In Arab countries, the restaurant chain offers “halal” menus, which comply with Islamic laws governing the preparation of meat. In 1996, McDonald’s entered India for the first time, where it offered a Big Mac made with lamb called the Maharaja Mac, and later they introduced the Chicken Maharaja Mac.

McDonald’s is not a complex business—after all, it sells inexpensive burgers and fries, not automobiles or airplanes or pharmaceuticals—but clearly the global environment presents challenges even for them. You may be wondering why nations and businesses decide to take on such challenges, given the ongoing difficulty, risk, and uncertainty. We’ll investigate this question throughout the remainder of this module.

2. Why Nations Trade

One might argue that the best way to protect workers and the domestic economy is to stop trade with other nations. Then the whole circular flow of inputs and outputs would stay within our borders. But if we decided to do that, how would we get resources like cobalt and coffee beans? The United States simply can’t produce some things, and it can’t manufacture some products, such as steel and most clothing, at the low costs we’re used to. The fact is that nations—like people—are good at producing different things: you may be better at balancing a ledger than repairing a car. In that case you benefit by “exporting” your bookkeeping services and “importing” the car repairs you need from a good mechanic. Economists refer to specialization like this as advantage.

Absolute Advantage

A country has an absolute advantage when it can produce and sell a product at a lower cost than any other country or when it is the only country that can provide a product. The United States, for example, has an absolute advantage in reusable spacecraft and other high-tech items.

Suppose that the United States has an absolute advantage in air traffic control systems for busy airports and that Brazil has an absolute advantage in coffee. The United States does not have the proper climate for growing coffee, and Brazil lacks the technology to develop air traffic control systems. Both countries would gain by exchanging air traffic control systems for coffee.

Comparative Advantage

Even if the United States had an absolute advantage in both coffee and air traffic control systems, it should still specialize and engage in trade. Why? The reason is the principle of comparative advantage, which says that each country should specialize in the products that it can produce most readily and cheaply and trade those products for goods that foreign countries can produce most readily and cheaply. This specialization ensures greater product availability and lower prices.

For example, India and Vietnam have a comparative advantage in producing clothing because of lower labor costs. Japan has long held a comparative advantage in consumer electronics because of technological expertise. The United States has an advantage in computer software, airplanes, some agricultural products, heavy machinery, and jet engines.

Thus, comparative advantage acts as a stimulus to trade. When nations allow their citizens to trade whatever goods and services they choose without government regulation, free trade exists. Free trade is the policy of permitting the people and businesses of a country to buy and sell where they please without restrictions. The opposite of free trade is protectionism, in which a nation protects its home industries from outside competition by establishing artificial barriers such as tariffs and quotas. In the next section, we’ll look at the various barriers, some natural and some created by governments, that restrict free trade.

The Fear of Trade and Globalization

The continued protests during meetings of the World Trade Organization and the protests during the convocations of the World Bank and the International Monetary Fund (the three organizations are discussed later in the chapter) show that many people fear world trade and globalization. What do they fear? The negatives of global trade are as follows:

  • Millions of Americans have lost jobs due to imports or production shifting abroad. Most find new jobs, but often those jobs pay less.
  • Millions of others fear losing their jobs, especially at those companies operating under competitive pressure.
  • Employers often threaten to export jobs if workers do not accept pay cuts.
  • Service and white-collar jobs are increasingly vulnerable to operations moving offshore.

Sending domestic jobs to another country is called outsourcing, a topic you can explore in more depth. Many U.S. companies, such as Dell, IBM, and AT&T, have set up call service centers in India, the Philippines, and other countries. Now even engineering and research and development jobs are being outsourced. Outsourcing and “American jobs” were a big part of the 2016 presidential election with Carrier’s plan to close a plant in Indianapolis and open a new plant in Mexico. While intervention by President Trump did lead to 800 jobs remaining in Indianapolis, Carrier later informed the state of Indiana that it would cut 632 workers from its Indianapolis factory. The manufacturing jobs will move to Monterrey, Mexico, where the minimum wage is $3.90 per day.15

Exhibit 3.3 Anti-globalization groups oppose America’s free-trade stance, arguing that corporate interests are hurting the U.S. economy and usurping the power of the American people. The recent protests at the G20 meetings in Hamburg, Germany, expressed anti-free-trade sentiment, supporting the idea that multinational corporations wield too much power. Are fears expressed by anti-globalization activists and nationalists justified? (Credit: fiction of reality/ Flickr/ Attribution 2.0 Generic (CC BY 2.0))

So is outsourcing good or bad? If you happen to lose your job, it’s obviously bad for you. However, some economists say it leads to cheaper goods and services for U.S. consumers because costs are lower. Also, it should stimulate exports to fast-growing countries. No one knows how many jobs will be lost to outsourcing in coming years. According to estimates, almost 2.4 million U.S. jobs were outsourced in 2015.16

Benefits of Globalization

A closer look reveals that globalization has been the engine that creates jobs and wealth. Benefits of global trade include the following:

  • Productivity grows more quickly when countries produce goods and services in which they have a comparative advantage. Living standards can increase faster. One problem is that big G20 countries have added more than 1,200 restrictive export and import measures since 2008.
  • Global competition and cheap imports keep prices down, so inflation is less likely to stop economic growth. However, in some cases this is not working because countries manipulate their currency to get a price advantage.
  • An open economy spurs innovation with fresh ideas from abroad.
  • Through infusion of foreign capital and technology, global trade provides poor countries with the chance to develop economically by spreading prosperity.
  • More information is shared between two trading partners that may not have much in common initially, including insight into local cultures and customs, which may help the two nations expand their collective knowledge and learn ways to compete globally.


3. Absolute and Comparative Advantage

Absolute and Comparative Advantage

banana tree with a large bunch of bananas

Consider the humble banana. Even if you’re not a big fan of this yellow fruit, you’ve surely seen them in the grocery store or in a market somewhere. If you walked through a U.S. city with a banana and asked people to identify it, it’s unlikely you would encounter anyone who had no idea what it was. What if you did the same thing with a picture of a banana tree? How many people could identify it? Maybe some, but not all. Why is that? In the United States, bananas are grown in Hawaii, and not everyone has been to Hawaii. In fact, most of the bananas in the world are grown in Ecuador. If we Americans love bananas and don’t live in Hawaii and can’t get to Ecuador regularly, without global trade, we’re out of luck: no bananas for cereal in the morning or as snacks during the day, and worse, no banana splits at the local ice cream parlor. Why do Ecuador and Hawaii trade away their bananas instead of keeping them all to themselves? Probably because, although bananas are delicious and nutritious, it’s hard to build houses out of them. Instead, the state of Hawaii and nation of Ecuador choose to trade their bananas for things they lack, while considering the cost and profitability of exporting their product.

Ecuador and Hawaii offer an example of comparative advantage. Because bananas are not grown or readily available everywhere in the world, Ecuador and Hawaii can profitably export theirs to banana-less places like Iowa and Canada. At the same time, Ecuador may need computer systems to keep track of all of those bananas they are selling, but Ecuador is not a technologically advanced economy like the United States. The United States has a comparative advantage in computers, so we sell our computers to Ecuador and let them concentrate on selling us bananas.

Advantage

In order to understand why businesses are willing to operate in a complex global environment, we must first understand two fundamental concepts that drive almost all business decisions: absolute and comparative advantage. Countries and companies are willing to assume the risk of engaging in global trade, because they believe that they have an advantage over the competition that they can turn into profits. Not all countries have the same natural resources, infrastructure, labor force, or technology. These differences create advantages that can be exploited in global trade, to a country’s (or company’s) benefit.

Absolute Advantage

An entity (country, region, company, or individual) is considered to have an absolute advantage if either of the following conditions exists:

  1. It is the only source of a particular product, good, or service. This kind of absolute advantage is very rare and usually depends on a particular natural resource being available only within a certain region or country. An example might be the coveted edible red bird’s nests found only in the caves of Thailand (and prized in Chinese cooking as the main ingredient in bird’s nest soup). Similarly, if Ecuador were the only place in the world where bananas could be grown, it would have an absolute advantage. However, suppose some sneaky banana spy goes to Ecuador and pilfers some banana tree seedlings and takes them back to her home country and begins growing and exporting bananas. At that point, Ecuador no longer has an absolute advantage on the basis of the “only-source” condition.
  2. An entity is also considered to have an absolute advantage if it is able to produce more of something than another entity while using the same amount of resources (factors of production). When the sneaky banana spy started growing bananas in her home country, she didn’t actually take away Ecuador’s absolute advantage, because Ecuador can produce more bananas using the same amount of resources (labor, land, water, equipment, etc.). Put another way, Ecuador’s direct cost of producing bananas is lower than the banana spy’s. Assuming that the bananas can be grown in the new country, it will take that country a very long time to match Ecuador’s skill, efficiency, and output level, and until it does, Ecuador will retain its absolute advantage.

Comparative Advantage

An entity (country, region, company, or individual) is considered to have a comparative advantage over another in producing a particular good or service if it can produce the good or service at a lower relative opportunity cost.

You’ll recall from the economic environment module that opportunity cost is the value of the next best alternative. (The video, below, also includes a refresher on this concept.) Since countries and businesses have limited resources, they are forced to make choices about how they allocate those resources. As a student, you understand opportunity cost better than you think. You have a limited amount of time, and you must choose between reading this module and going out with your friends, because you can’t do both. If you choose to go out with your friends, then the opportunity cost might be a failure on your next exam, because you did not use the time to prepare.

Ecuador has a comparative advantage in bananas over a long list of countries, including the United States. This comparative advantage is even better understood when you consider that their next best alternative product is oil. The Middle Eastern countries have been pumping oil from the ground for as long as Ecuador has been growing bananas. It makes as much sense for Kuwait to attempt to export bananas as it does for Ecuador to export oil. It’s the reality of comparative advantage that encourages countries and businesses to do what they do best—leaving the production of other goods and services to other countries or companies—and in so doing, focusing on producing goods and services where they have advantage, thus maximizing their opportunities in a global environment.

The following video provides an excellent illustration of comparative and absolute advantage and explains why they are such important considerations in how countries decide to specialize and trade.

You can view the transcript for “Episode 34: Comparative Advantage & Trade” (opens in new window) or the text alternative for “Episode 34: Comparative Advantage & Trade” (opens in new window).

4. Global Markets

Global Markets and Business Opportunity

many brightly colored LEGO people

Increasingly, nations and business use their comparative or absolute advantages to enter global markets driven by the same factor: the immense size of these markets.

Three people wearing banana costumes

Let’s return to the banana for a moment. In 2015, Ecuador exported 6.55 million metric tons of bananas. Without a large global demand for bananas, every man, woman, and child in Ecuador would have to eat 834 pounds of them per year to consume all of the production. Of course that wouldn’t happen: instead, the country would simply cut back on the production of bananas—but, in so doing, it would lose an export that now accounts for more than 10 percent of its gross domestic product (GDP). Ecuador needs a large and vibrant global market to keep up with its tremendous supply of bananas, and it relies on the revenue from those bananas to purchase the other things it needs.

Later in this module we’ll discuss how nations like Ecuador enter foreign markets, but for now let’s look more closely at the size of the world’s largest markets. The following table shows population and GDP data for the top five economies in the world as of 2017.[1] You’ll recall from the economic environment module that GDP, or gross domestic product, is a monetary measure of the market value of all final goods and services produced in a period, and the GDP growth rate is the increase or decrease in GDP over a period of time, expressed as a percentage.

Top Five Economies in the World as of 2017
Country GDP Population GDP Growth Rate
China $23,210,000,000,000 1,384,688,986 6.9%
United States $19,490,000,000,000 329,256,465 2.2%
India $9,474,000,000,000 1,296,834,042 6.7%
Japan $5,443,000,000,000 126,168,156 1.7%
Germany $4,199,000,000,000 80,457,737 2.5%

Looking at the figures in this table, it isn’t hard to imagine that a country or company would like to have a foothold in one or all of these markets. Taken together, these five economies represent a lot of people, a lot of purchasing power, and a lot of economic growth. However, the immensity of the global market offers more than just new target customers.

Consider some of the following benefits nations and firms realize by entering foreign markets.

Access to Factors of Production

The factors of production required for a successful business venture are natural resources, capital, human capital, and entrepreneurship. Access to global markets enables countries and companies to acquire these factors of production when they are nonexistent, scarce, or just too costly at home. For example, India is one of the largest providers of telephone-based customer service (labor) worldwide, which makes sense given that its population is second only to China and almost four times that of the United States. In addition, labor costs in India are significantly lower than in the United States. 

Innovation and Ideas

Many companies enter global markets, and, once there, discover unmet needs or unique products and services. They are then able to use their discoveries to expand an existing product line or introduce new products in other markets or at home. For example, many people credit the United Kingdom with inspiring the development of the craft beer industry in the United States.

Risk Reduction

Given the complexity of operating a business globally, it may seem like a contradiction that risk reduction is one of the benefits of a large global market, but it’s actually true. If a country or a company trades or does business with multiple foreign partners, they are less dependent on the success of any single partnership. Likewise, if a nation or business has multiple global sources for factors of production, then if one source “dries up,” they will still have access to what they need. For example, in 2010, China halted its export of rare earth minerals to Japan after the two countries were unable to resolve a territory dispute. Japan used these minerals in the production of everything from cars to computer chips, and to say that the Japanese were in a state of distress is an understatement. As a result of this albeit brief reduction in Chinese supply, Japan established a trade agreement with India for the import of the needed materials. They will no longer be totally dependent upon the Chinese for these important resources.

In summary, globalization makes business on a global scale possible, and the size of the global market makes it attractive. By using their absolute and comparative advantages, countries and companies can leverage their resources to produce and trade the things that benefit them the most.

LICENSES AND ATTRIBUTIONS

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  • Introduction to Globalization. Authored by: Linda Williams and Lumen Learning. License: CC BY: Attribution
  • Globalization and Global Business. Authored by: Linda S Williams and Lumen Learning. License: CC BY: Attribution
  • Absolute and Comparative Advantage. Authored by: Linda Williams. Provided by: Lumen Learning. License: CC BY: Attribution
  • Game: Absolute and Comparative Advantage. Authored by: Bob Danielson. Provided by: Lumen Learning. License: CC BY: Attribution
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  • Globalization Easily Explained. Provided by: Explainity. Located at: https://youtu.be/QXN_jl2abEE. License: All Rights Reserved. License Terms: Standard YouTube license
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