In a world that has achieved the relatively free flow of ideas and capital, the development of emerging economies is bound to be much faster than that of their Western counter parts, especially in modern modes of production, communication, and distribution. Emerging market economies also have a significant structural advantage grounded in the operation of the global economy. Trade negotiators often complain about the suppressed exchange rates of emerging economies like China, but fail to take into consideration that the prime commodity of these countries is its citizens and their ability to provide a labor pool. Labor cannot be treated as having the same freedom of movement as ideas or capital, or for that matter as being similar to commodities.
Any company sourcing its production or service operations in a lower-wage emerging-market country therefore can save enormously on labor costs. That’s painful for displaced Western workers, but it’s good for the company’s profits, good for consumers in developed markets, and good for the newly minted citizens of the global economy who are working in emerging-market factories and call centers. However, given the changes that happen with every economic crisis, this is not likely to continue for long.
Financial crises will accelerate the leveling of playing fields between the developing and developed nations. Take for example the recent decision by China to relax its peg on the exchange rate of the yuan. The changing position will have long term implications on global trade and the operations related to trade. If the process is sudden, companies need to be prepared for the tremors that will follow, until a new global equilibrium is established.
Integration of the world economy will be real when goods are available to all customers at the same price, but this is almost never the case. The reason is the factors of production, whose cost varies from place to place. Land, capital and labor are all factors whose cost varies from place to place, country to country, and whose variation affects the final cost of any product. If the cost of these is the same for all, integration will be much faster. Such market conditions have long existed at a global level for natural commodities, such as crude oil, bauxite, and iron ore, as well as for manufactured commodities, such as petroleum, aluminum, and steel. The law of one price also exists for freely traded foreign exchange and most instruments traded in the capital market. It does not exist for labor, however—which is the fundamental structural issue the global economy faces.
However, with the recession, companies have been relocating more of their production needs to emerging labor markets in Asia, where the skill sets have been rapidly rising from the low end to highly skilled technically superior tasks. As more and more of the production shifts to emergent economies, the pressure on currency values will continue to build till the trade imbalance forces a realignment of economic realities.
Another aspect is commodity price. Since currencies in emerging economies are suppressed, they end up paying more for the same raw materials than the developed nations. This creates pressure on the developing nations to raise their currency exchange rate to make imports cheaper.
It is difficult to predict how the whole set of issues will play out, but the ultimate point is convergence of values till the whole world is one level playing field. If major national governments work proactively together to rebalance and coordinate their fiscal, monetary, trade, and foreign-exchange policies, the adjustment process could be gradual. But this is easier said than done. Each of the large economies can and does exert a significant influence on the global capital market, and often do so to preserve status quo, as China’s example shows. However, the longer they delay the shifting paradigm, the more violent and sudden the changes that will ultimately take place.
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