GED Explains: Globalization – How Much is Too Much?

Economic globalization increased worldwide until the financial and economic crisis broke out following the Lehman bankruptcy in 2008. Since then it has faltered – particularly, but not exclusively, in developed national economies. It remains unclear whether this is a temporary or lasting phenomenon. It is equally unclear if the slowdown in globalization is to be seen positively or negatively. Many national economies may have already reached their optimal degree of globalization, meaning that – from a purely economic viewpoint – further advances in globalization no longer make any sense for them.

Costs and benefits of globalization

The question of whether a certain degree of economic globalization makes sense or not in economic terms can be answered theoretically at least. To do so, the advantages that are associated with advancing globalization need to be compared with the disadvantages.

Advancing globalization has a number of advantages. Specializing in the production of goods that brings cost advantages to a country promotes economic growth. The cross-border mobility of production factors ensures optimal factor allocation and therefore leads to increased productivity and growth. International competition promotes innovation and productivity. Ultimately, these positive effects lead to an increase in economic growth, a reduction of poverty and a rise in employment. For the people, this means an improvement of material and immaterial living conditions (improved health, increased life expectancy, etc.).

At the same time, negative developments also go hand in hand with increased economic globalization. The cross-border trade in goods increases the emission of CO₂ and other greenhouse gases. This leads to an increase in the average global temperature and the acceleration of climate change. Within the individual countries, globalization can increase social tension because the opening of markets changes the scarcity conditions in each country and therefore produces not only winners, but losers too.  In developed national economies, the losers are predominantly low-skilled workers. Finally, it cannot be ruled out that companies will lower their standards of social protection with a view to maintaining their level of international competitiveness.

Theoretical determination of the optimal degree of globalization

Using these advantages and disadvantages, the optimal degree of globalization for an economy can be determined at least theoretically. From an economic viewpoint, an increase in globalization makes sense if the associated additional social utility (marginal utility) is larger than the additional overall economic costs (marginal costs).

The marginal utility of globalization denotes the additional utility that a national economy gains from increasing its international interdependence by an additional unit. In economics, the ‘law of diminishing marginal utility’ is applied: It stipulates that the marginal utility of a product will decline as consumption of this product increases. The additional consumption does lead to a rise in overall utility, but these increases get progressively smaller the more it is consumed.

Applied to globalization, this means the following: if a national economy that is completely closed off to begin with opens up its borders in order to trade with other countries, this will initially result in major advantages such as a reduction of poverty and an increase in prosperity and employment. Every increase in globalization leads to macrosocial utility gains. However, the higher the level of globalization already attained, the lower the utility gains will be.

The marginal costs of globalization indicate how the macrosocial costs of globalization change if the degree of globalization is increased by an infinitesimally small amount. These costs include both the direct costs (particularly the value of consumed resources that go hand in hand with increasing globalization, as measured in monetary units) and the indirect costs, i.e. the resulting ecological and social costs (environmental pollution, climate change, social instabilities, etc.). Normally economic models assume that the ‘law of increasing marginal costs’ applies. This means that the expansion of an economic activity is associated with increasing costs and that the costs increase exponentially.

Graphical determination of the optimal degree of globalization

Using these assumptions regarding the overall economic marginal costs and the overall economic marginal utility of globalization, one can determine the optimal degree of globalization for a national economy (see Fig. 1):

• Based on a state of complete economic isolation (degree of globalization g = 0), the economic globalization of the country in question is initially associated with relatively major advantages and relatively minor disadvantages. Until the degree of globalization g* has been reached, the advantages of advancing globalization outweigh the disadvantages, meaning that a further increase of international economic interdependence makes sense.
• However, once this level has been reached, stepping up cross-border interdependence no longer makes sense from an economic viewpoint, because the additional costs are greater than the associated additional utility. If a country has surpassed the optimal degree of globalization g*, a reduction of globalization – i.e. a de-globalization – makes sense.

Empirical determination of the optimal degree of globalization

One can therefore determine in theory the point up to which an increase in globalization still makes sense. However, whether the economic limit to globalization has already been reached or not in a national economy is difficult to ascertain in practice. To do so, it is necessary to precisely quantify the marginal utility curve and the marginal cost curve as a function of the degree of globalization, which has up until now been beyond the limits of economic analysis capabilities.

Nonetheless, it is still possible at least to make the basic statement that the advantages of globalization depend on the size of the country in question:

• Small economies such as Belgium, Ireland and the Netherlands only have a small internal market. The sale of their products to consumers in other countries is necessary to lower the fixed costs of production. Furthermore, the small internal market means that many pre-products on which domestic companies are dependent are either not available nationally – or are only available at very high prices. Small countries are therefore particularly reliant on open borders, meaning that the advantages of economic globalization are relatively high.
• Big economies such as the USA and China, however, have a large internal market with lots of consumers. This enables companies to exploit the advantages of mass production without producing for foreign markets. Moreover, they can obtain many pre-products nationally. As a consequence, large countries are less dependent on international ties. This, in turn, means the advantages of economic globalization are smaller.

On the graph, these differences are expressed by the fact that a small country’s marginal utility curve lies above the corresponding curve of a big country with respect to the degree of globalization (see Fig. 2). Consequently, the optimal degree of globalization of a small country is greater than that of a big national economy. Indeed, small countries such as Ireland, Belgium and the Netherlands show systematically higher degrees of economic globalization than big countries such as the USA, Japan and China.

Summary

Globalization, much like all economic phenomena, comes with advantages and disadvantages. There is therefore also a certain degree of globalization beyond which the disadvantages outweigh the advantages. If this degree of globalization is reached in a country, it no longer makes sense for this country to further intensify its level of international economic interdependence. But since a monetary assessment of these advantages and disadvantages is not possible, it is impossible to say empirically whether individual countries have already reached, or even surpassed, their optimal degree of globalization.  In any case, however, it is clear that a never-ending intensification of economic globalization does not make sense and that there are therefore economic limits to globalization.

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