In kicking off the Wharton Global Alumni Forum 2005 in London earlier this month, Stephane Garelli, professor at the International Institute for Management Development, and Paul Judge, chairman of the Royal Society of Arts, Manufactures and Commerce, looked at globalization’s impact on growth and prosperity in different regions of the world. Their conclusions: Globalization has indeed affected social and economic conditions, but not always for the better.
In Garelli’s whirlwind tour of the international marketplace, he noted that business has two functions: managing efficiency, i.e., how much money we make; and managing change, i.e., how we adapt to the world around us. That global community is no longer avoidable, even though our lives “would probably be easier if the world would stop tampering with our strategy.” Since it won’t, that means “more market risk than ever, more operational risk than ever, and always a good chance that something will go wrong somewhere in the world.”
The global economy is struggling, he said. Europe experienced 1.4% growth in the first quarter, “not as good as we would have expected,” although the U.K. overall showed 2.8% first quarter growth. Central Europe is “getting better”: Poland grew 2.1% in the first quarter, and Hungary 3.8% and the Czech Republic 4.3%, both in the fourth quarter.
In Latin America, Venezuela “shows good numbers” — 7.9% first quarter growth — because of oil prices; “Argentina is coming back (8.4% fourth quarter growth) and Brazil is a little disappointing (2.9% first quarter growth). “The numbers in Asia are good,” ranging from 6.2% fourth quarter growth in India and 5.1% fourth quarter growth in Thailand to 9.4% first quarter growth in China. In the U.S., 2003 saw “a good economic recovery, while 2004 was a year of consolidation.” Specifically, growth in the second, third and fourth quarters 2004 were 4.8%, 3.9% and 3.9%. Growth in the first quarter 2005 was 3.6%.
Two key figures in the world economy are the U.S. balance of trade deficit and the budget deficit. The balance of trade deficit now stands at $644 billion, 5.5% of GDP. “The real news is imports,” Garelli said, noting that 20% of the products imported are not foreign products; they are from American companies manufacturing abroad and shipping the products back into the U.S. where they are sold on the market as American brands.
“The budget deficit is more disquieting,” he said. Under President Clinton, the budget had a 1.4% surplus; under Bush, it has a 4% deficit. In addition, foreign holdings of U.S. Treasury bonds and agency bonds, which were at $850 billion in 2002, now stand at $1.6 trillion. “George Washington said there is no practice more dangerous than borrowing money. Thank goodness nobody thinks about George Washington anymore,” quipped Garelli, who also is a professor at the University of Lausanne. He expects to see two separate strategies: In the U.S., interest rates will gradually rise in order to attract investors, while in Europe, which also has significant corporate debt, interest rates will gradually decrease to sustain growth.
So how bad are things, Garelli wondered, then answered with a quote from Mark Twain. Asked what he thought about the music of Richard Wagner, Twain responded: “It’s not as bad as it sounds.” The economy, Garelli suggested, “is not as bad as it sounds…. As Madonna says, we are living in a material world.” Or, translated into economic terms, those who made money last year were in raw materials. “The prices of raw materials and commodities are exploding…. The price of oil has been booming,” he said, noting that the price per ton of rolled steel was $300 in January 2004; by December it was $590. The price of a barrel of oil closed above $60 on Monday, 58% higher than a year ago.
“Why are raw materials so hot today? Because of China, whose appetite for raw materials and commodities is enormous.” China consumes 31% of the world’s coal, 27% of its steel, 19% of its aluminum, 33% of its fish, 35% of its cigarettes, 20% of its cell phones, 23% of its TVs and 19% of its ice cream — but only 7.7% of its oil.
The Big Movers
The additional hot news for 2005, said Garelli, is that “Russia is taking off, with 6% growth from 1999 to 2004 and the greatest supply of natural resources in the world.” Japan, with the world’s second largest economy, should be “back in the picture,” with 1.2% growth in the first quarter. The “big movers,” he says, will be Russia, which can supply all the raw materials, Japan the technology, China the manufacturing and India the services. “It’s a new world coming in.”
Over the next 10 years in that new world, we will see 700 million people join the labor market in developing countries; by 2030, 60% of the world’s population will be living in urban areas. In addition, the world is getting older. France had six workers for one retiree in 1950; in 2050 it will have two workers for one retiree. In Italy, 62% of workers retire at 55. In the Organization for Economic Co-operation and Development (OECD), one person out of three will be older than 60 by the year 2050.
The action, Garelli predicted, will be in the East with low cost manufacturing, which will lead to increased purchasing power, which will lead to the conversion of India, China and other countries into “brand providers,” a process that is already happening. In India, for example, well-known brands include Infosys, Wipro, Reliance, Tata and TransWorks; in China there is Haier, Konka, Lenovo, TCL and Skyworth.
What has been the impact on business of this new order? A three-step revolution, Garelli said. In the 1980s, it was all about working better through reengineering, which brought greater product efficiency but not much improvement in service efficiency. “In the 1990s it was about working cheaper through outsourcing, which brought more cost efficiency but more complexity as well. And in 2000 it was about working elsewhere, which has brought offshoring.”
Cost efficiency “is good news,” Garelli suggested. “The bad news is complexity. The value chain in a global world is leaner, but longer because we have more partners today than 10 years ago. The cost of adding more partners is we have to manage them. More partners mean more back-office operations.” Garelli quoted Jeff Immelt, CEO of GE, who said recently that “40% of the company is now administration, finance and backroom functions. Over the next three years I want to shrink that by 75%.”
The consequences of these developments is that “we are in a world of more transactions, more vulnerability” and far too much complexity. “We need to simplify things,” Garelli said, quoting Albert Einstein’s maxim that “Everything should be made as simple as possible, but not simpler.” The impact of complexity on customers, for example, can be profound, including the risk that companies become unreachable and too remote from the customer because of processes that are overly cumbersome and ultimately inefficient. As one employee said to another in a recent cartoon: “The new automated ordering system has really speeded up our business. We’re losing customers faster than ever.” The real issue, said Garelli, “is management and services around the product, not the product itself. That is where customer dissatisfaction comes from.”
Customers are becoming part of the value chain, Garelli added. “At easyJet, you book your flight on the Internet, check in automatically and don’t meet an employee of the company until you step onto the plane. Ikea has outsourced everything to customers, including assembly.” Other companies with similar business models include Dell, Amazon.com and eBay. Rather than the do-it-all company, “we now have the ‘do-it-myself’ customer,” Garelli suggested.
So what competencies and skills are needed to survive? “We have to challenge conventional wisdom,” he noted. “We always say, ‘People are our most valuable assets.’ Wrong. Only the right ones are. We always say, ‘We need competent people.’ Wrong. We need competitive people.” Who are these competitive people? Those with a “sense of action and a high level of energy and decision making.” In addition, the “‘right’ people will have a sense of purpose, will lead the way (even when lost), will be open-minded, will manage ambitions, and will turn the world upside down.”
Give Trade a Chance
In Paul Judge’s perspective on 250 years of globalization — the theme of the conference — he compared England 250 years ago to England and the rest of the world today. The English economy in the 1700s relied on goods made in cottage industries; work was labor-intensive, productivity was low, and machinery didn’t exist so there was no need for financial capital. When the Agricultural Revolution began in the early 1700s — as the precursor to the Industrial Revolution — increased mechanization meant that fewer workers were needed on farms and thus rural unemployment rose. People in search of work moved to cities. Huge disparities in wealth and well-being became more pronounced. Between 1750 and 1774, close to 34% of people died in their first year; a further 9% died by the age of 4, and 49.7% died by the age of 20.
Because of globalization, people in rich countries today have many advantages, Judge said, but outside the developed world, the picture is different. “We are seeing in the developing world what we saw in England in the 1750s — lack of housing, sanitation and medical care.”
High income people represent 16% of the world’s population, while low income people make up the rest, as they did in England in 1750, said Judge, citing figures from the World Bank. GNP on a per capita basis for high income countries is $27,000 vs. $3,700 for low income countries. Electric consumption per capita is 8,615 kilowatt hours in high income countries vs. 913 in low income. The amount of money spent on healthcare per person is $2,700 vs. $71. Lack of sanitation and medical care — two billion people have no water; 11 million children die annually from treatable diseases — is exacerbated by cultural change, similar to the situation in London in the 1750s.
How does one redistribute income from rich countries to poor countries, Judge asked. The answer is “through charity, aid and trade.” With regards to charity, Judge said, the experience of the U.K. over the past 250 years is that the amount of money given voluntarily from the rich to the poor tends to be low. (In the U.S., the total is $15 billion; in the U.K., it is $1 billion.) “Individual projects can do well, but they have limited overall impact.” Aid totals 1.8% of world income, which translates to about $80 billion a year, or about $10 to $15 per person. The U.S. gives close to $19 billion in aid, or 0.16% of GNP. Japan gives $8.85 billion in aid, or 0.19% of GNP; France, $8.47 billion or 0.42%; the U.K., $7.83 billion or 0.36%; Germany, $7.49 billion or 0.28%; the Netherlands, $4.23 billion, or 0.74%; Sweden, $2.7 billion or 0.77%; Spain, $2.55 billion or 0.26%; Canada, 2.53 billion or 0.26%; and Italy, $2.5 billion, or 0.15%.
The third means by which income is redistributed is trade, or “transactions between individuals and organizations across borders through Adam Smith’s invisible hand,” said Judge. “Trade flows are the answer to making substantial differences. But we often don’t give developing countries enough of a chance in trade. The West pays substantial subsidies to its comparatively small number of farmers, which depresses world prices. The West also has extensive tariffs on raw materials and basic manufactured goods, the very items that developing countries can export.”
Judge cited a quote from Oxfam: “If Africa, East Asia, South Asia and Latin America were each to increase their share of world exports by 1%, the resulting gains in income could lift 128 million people out of poverty. In Africa alone, this would generate $70 billion — approximately five times what the continent receives in aid.”
Trade, said Judge, “is not a level playing field.” Consider agricultural subsidies: Rich countries spend $1 billion every day on agricultural subsidies, or about $350 billion per year. The average European cow gets a $2-per-day subsidy. Meanwhile, 800 million people live on less than a dollar a day. As for tariff barriers, he said, “the imports of commodities, textiles and other exportable items are restricted or surcharged. These barriers cost developing countries $100 billion a year — more than they receive in aid.”
The world, he added, has come a long way since the 1750s, but “it’s North America and Europe that have benefited the most. The other five billion people are still living in a situation” similar to London in the 18th century. “The greatest hope for people in lower and middle income countries rests with allowing them to trade on fair terms.”