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Let’s get this confession out of the way first. Investment and Business News is a fan of globalisation because it seems it is perhaps the single greatest force ever seen for creating wealth. Critics of globalisation who say it causes poverty, fail to realise that actually what it really does is expose poverty that already exists. The workers labouring in horrendous conditions in sweatshops often take these jobs because their previous jobs were even worse.

But just because globalisation creates wealth, it doesn’t mean it is all good. Every plus comes with a negative. And here is one powerful reason why globalisation actually may have caused the economic crisis of our times, and why recent data may indicate this underlying downside of globalisation has not gone away.

The problem lies in what the IMF calls the globalisation of labour. New data from the US supports the argument that forms this article’s gist, while grist is added to the mill by a new report from Ernst & Young.

Okay, before we get going, let’s finish the argument about globalisation. A few years ago it emerged that Wal-Mart was buying clothes from a manufacturer which employed workers in sweatshop-type conditions. US senator Tom Harkin took up the cause, until Wal-Mart eventually cancelled its contract with the supplier.

Some time later, research from Oxfam revealed that as a result, 50,000 workers lost their jobs, many of whom were then subjected to appalling poverty, and many resorted to prostitution as a way to survive.
The arguments against globalisation are complicated, and actions can have surprising consequences.

Or take this argument, taken from an article in The Economist 22 December 2007, headlined “Noble or Savage”: “The Dickensian view is that factories replaced a rural idyll with urban misery, poverty pollution and illness. Factories were indeed miserable and the urban poor overworked and underfed. But they flocked to take jobs in factories to get away from the cold, muddy starving rural hell of their birth.”

Globalisation often has the effect of creating an industrial revolution in some regions; it is this, and not globalisation itself, that creates both wealth and poverty.

But, there is another side. Globalisation is creating super profits for large corporations, but is making the market for labour more competitive. As a result, it seems the rewards from wealth creation are drifting away from labour to business.

Back in December 2006, Justin Fox penned a piece for Fortune Magazine in which he observed that US corporate profits (that’s after paying tax) were running at 10.1 per cent of US GDP. The ratio had never been so high – at least Commerce Department’s data, which goes back 87 years, had never recorded it so high. But it did come close to that level once before; back in 1929 the ratio of profits to GDP hit 8.9 percent.

So was the Fox finding an early hint of troubles ahead, or was it all just a coincidence? After all, lots of things happened in the noughties that also happened in 1929, but they didn’t all lead to economic crisis.

On the other hand, recent data from the US has indicated that corporate margins are on the up again, and are approaching the record 2006 level. The US gross operating surplus was 29 per cent in Q4, compared to 29.9 per cent in 2006. And labour’s share of income generated by US non-financial companies dropped to 62 per cent, almost as low as in 2006.

So what? – corporates are making more money, labour is earning less. How can that explain why we had an economic crisis?

But what happens when we get used to seeing our income rising, and then all of a sudden it stops increasing so fast? Maybe we assume this is a short-term problem only, so we carry on upping our spending. In short, we borrow more. And if house prices rise, we feel wealthier, and thus are more relaxed about borrowing more. This is what happened in the noughties. Consumers funded their spending via debt, instead of via higher income. Those who argued there was no crisis in the making said that consumer spending was only rising at a modest rate, and that therefore there was no bubble. What they failed to realise is that while the economy was growing, consumers were not getting better off. In fact, lots of studies came out in the 2006/07 period warning that our discretional disposable income – that’s income after we have bought things we have no control over, such as cost of travelling to work and utility bills – was falling.

So the scenario runs like this. The economy was growing and consumer spending was growing, but not especially fast in comparison to economic growth. Therefore, concluded economists and central bankers, there was no bubble. They concluded that falling house prices would not be a problem for the economy, because clearly consumer spending was sustainable as its growth had been modest.

They were wrong. And they were wrong because they failed to grasp that the consumer’s slice of the GDP cake was getting smaller. Consumer spending may have been growing at a modest rate, but given the effect globalisation was having on discretional disposable income it was a miracle it was growing at all.

And this brings us to Ernst & Young.

In their spring 2010 Economic Outlook report, the Ernst & Young ITEM Club said: “The pressure on households resumes as companies bounce back. The ‘globalisation of labour’ meant that the growth in consumer spending saddled households with huge debt, while major companies ran big surpluses.”

The report said: “The household sector’s share of national income is counter-cyclical and last year this shot up from 70.3 to 73 per cent. However, comparing this with the two previous low cycle values of 77 per cent in 1991 and 76 per cent in 2001 reveals a clear deterioration. Similar downward trends in the labour force’s share of national income are evident in all western countries. This seems to reflect what IMF economists have dubbed the ‘globalisation of labour’. Immigration, import competition and off-shoring affect the provision of services as well as goods and the demand for skilled as well as unskilled labour, and these effects have clearly been at work in the UK. These adverse trends help to explain why the recent ‘consumer boom’ was so modest compared to the Lawson boom and other historical episodes – and why households had to borrow so much to sustain this.

“UK households shot to the top of the G7 borrowing league table between 2000 and 2007. Debt increased from 102 to 160 per cent of household income over this period. In the meantime, non-financial company debts remained relatively modest, increasing from just 14 to 18 per cent of GDP.”

And that is the problem. Wealth is being generated, but the proceeds from this wealth are not being distributed. Globalisation is creating a big gap between capital and labour. You may or may not think this is unfair, but it does seem that, from an economic growth point of view, it is counter-productive.
Summary: Globalisation: wealth or poverty creator? IMF and Ernst & Young ITEM Club point to globalisation of labour as cause of jobs competition and falling share of labour income. Benefit of growing economies shifts to business away from people as globalisation creates gap between capital and labour. Globalisation’s undistributed wealth counter-productive for economic growth.