Rule Maker Portfolio The Economics of Globalization

Bill Mann too often hears people say that a big problem with capitalism, specifically globalization, is that multinational companies are getting rich off the labors of poorly paid workers in developing countries. Certainly, globalization is not without its seedy side, but he doesn't think the model of exploiting less-expensive labor is the big problem. In fact, forcing companies to pay Western wages would be devastating.

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By Bill Mann (TMF Otter)
January 29, 2003

Before we get started, I'd like to recommend yesterday's Fool on the Hill article to you. Matt Richey does a great job of describing General Dynamics (NYSE: GD), the drivers for its recent rapid drop in share price, and whether the company offers an investment opportunity. Obviously, I think it does. I thought it did at $80, and I think it does now at $66. If you want to know our investment thesis on this top-tier defense contractor, give it a read.

What is true about economics is that everyone seems to have an opinion about it, but few really have any understanding of it. Economics is all about scarcity. If the government were to come out right now and say that every American has a right to an apartment in New York City, it wouldn't change the fact that there are a very limited number of apartments in New York City. And rest assured, once that constitutional right is asserted, those who build apartments in New York City are not going to rush back to build more. There'd be no money in it.

I read this opinion on a Fool discussion board the other day:

"And everything that isn't made in China is made in Thailand. Or The Philipines [sic]. Or Malaysia. Or Somewhere Else.... Which wouldn't, in my opinion, be a problem, if mutinational [sic] companies were paying foreign workers what American workers would make if the same products were manufactured here."

While we shouldn't sweat the spelling mistakes here, we absolutely, positively should sweat the logic employed. The argument: Multinational companies have exploited cheap labor in order to make the folks who run and own the company filthy rich. But their riches come at the expense of those who do the actual work. Further, these companies have eviscerated the American middle class by moving these jobs to foreign countries in the first place.

A reason these companies have gone overseas is that they can manufacture for substantially less than they could in the U.S. Many people think this is somehow criminal or highly immoral. While there is no denying that some pretty awful (nay, mind-numbingly awful) things have been done in the name of commerce, the opinion expressed above shows an ignorance of economics. It also displays an inability to even ask the right question, if one is truly worried about the plight of these poor foreign workers.

The question is not "How do their wages compare with those in the U.S. Rather, it is "How do their wages compare with others that are locally available?" According to a study done in 1998 by the Edward Graham Institute of International Economics, the wages paid by multinationals generally exceed wages for comparable local jobs by 25%. In the lowest-income countries, these wages were as much as eight times as high as the average per capita salary.

Multinationals cannot be blamed for the economic condition of the locality where the jobs are. They are there to take advantage of a global inefficiency: very little work in some parts of the world, very expensive labor in other parts of the world. Supply and demand.

At any rate, let's say these smart, powerful people did demand that factory workers in Thailand be paid wages comparable to American workers'. What then? The answer: Economics and the choices that millions of people make will decide whether such a mandate is beneficial or ultimately destructive.

So, you wanna buy a frame?
Let's take as an example a multinational-owned factory in Thailand that makes picture frames and employs, say, 100 unskilled workers. At present, these frames sell for $11, the price the market will bear for the product. If you were to force the company to pay American-scale wages, this selling price would no longer be economical for production. So, those $11 frames are now $83 apiece.

How many $11 frames would you buy? Would you be willing to buy the same number of frames at $83 each? Obviously not. That sound you just heard was the Thai frame factory closing down. And, remember, we're forcing every multinational to pay Western wages. This being the case, why wouldn't they just do that in the West? The key to making globalization beneficial for everyone is not to make it too expensive for those providing the jobs.

Simply stated, without the lower-wages component, there would be little benefit to many companies to have factories overseas. Producing goods overseas creates significantly higher transportation costs, lower efficiency of each man-hour of labor, and increases management costs. Why in the world, if the goods are being consumed here, would production be more beneficial anyplace else?

Would the benefit be a net of jobs in the U.S.? Not necessarily. Remember, those frames, even if they're produced much closer to the end point of consumption, will still be substantially more expensive to produce. Maybe the cost to consumers becomes $68. Thus, it is highly unlikely that the average person would purchase the same number of frames as he would at a cost of $11. The number of people required to produce less frames would be greatly reduced. So the score is: zero employees in Thailand, and a greatly reduced number of employees here in the U.S., in production, in transportation, in distribution, and at end sales. The whole picture-frame economy would be mauled, and keep in mind that this exercise was predicated on all multinational companies paying U.S.-comparable wages. The level of inflation, the decrease in economic activity, the rapid decampment of companies from developing countries, and the destruction caused to a multitude of companies would be absurd in nature.

Again, companies go overseas because they can produce goods and services cheaper there than in the developed world. By so doing, it wrings out economic efficiencies that otherwise would not be available. Economics drive companies to go overseas, not the other way around. Otherwise, certain products would not be available at all.

Many Rule Maker companies have significant overseas operations. For example, Coca-Cola (NYSE: KO) garners more than half its revenue from international sources, providing substantial employment in 200 countries around the globe. Were Coca-Cola and its bottlers forced to pay U.S. wages to all those employees, its products would be unavailable to a large portion of these populations, rendering a great number of those jobs unneeded. Paying living wages is an admirable goal. Forcing wage equality in places that have vastly different economic conditions, rather than providing a benefit to the local workers, would be a total disaster.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

If you're willing to pay $83 for a picture frame, Bill Mann wants to hear from you. He owns shares in General Dynamics. He is managing editor of The Motley Fool Select, where you can find his best Foolish stock ideas that you won't find anywhere else. The Motley Fool has a disclosure policy.

The Rule Maker Portfolio has had a cumulative investment of $44,500. As of Jan. 28, 2003, its current value of all cash and equities is $30,197.60. This equals an internal rate of return of -12.0% since the launch of the portfolio in February 1998.


 

Rule Maker Portfolio

  Ticker Company Price
 Change
 Daily Price
 % Change
 Price 
  AXP AMERICAN EXPRESS COMPANY 0.14 0.40% 35.16 
  KO THE COCA-COLA COMPANY (0.55) (1.34%) 40.55 
  NOK NOKIA CORP. 0.57 4.03% 14.72 
  JNJ JOHNSON & JOHNSON (0.64) (1.21%) 52.40 
  PFE PFIZER INC 0.55 1.83% 30.55 
  GD GENERAL DYNAMICS CORPORATION (0.49) (0.73%) 66.40 
  TROW PRICE T ROWE GROUP INC (0.42) (1.59%) 26.05 
  SGP SCHERING-PLOUGH CORPORATION (0.1) (0.52%) 19.05 
  COST COSTCO WHSL CORP NEW 0.11 0.38% 29.32 
      
  Trade Date # Shares Ticker Cost/Share Price  Total % Ret  
 05/26/98 95 AXP 35.38 35.16  -0.62%
 02/27/98 27 KO 69.11 40.55  -41.32%
 02/15/00 250 NOK 27.21 14.72  -45.91%
 04/03/01 30 JNJ 47.28 52.40  10.82%
 02/03/98 66 PFE 27.43 30.55  11.36%
 10/24/02 25 GD 79.98 66.40  -16.98%
 02/06/98 75 TROW 34.12 26.05  -23.65%
 08/21/98 44 SGP 47.99 19.05  -60.31%
 07/24/02 41 COST 35.89 29.32  -18.31%
      
  Trade Date # Shares Ticker Total Cost Current Value  Total Gain  
 05/26/98 95 AXP 3,360.87 3,340.20  -20.67 
 02/27/98 27 KO 1,865.89 1,094.85  -771.04 
 02/15/00 250 NOK 6,802.85 3,680.00  -3,122.85 
 04/03/01 30 JNJ 1,418.50 1,572.00  153.50 
 02/03/98 66 PFE 1,810.58 2,016.30  205.72 
 10/24/02 25 GD 1,999.50 1,660.00  -339.50 
 02/06/98 75 TROW 2,559.06 1,953.75  -605.31 
 08/21/98 44 SGP 2,111.70 838.20  -1,273.50 
 07/24/02 41 COST 1,471.49 1,202.12  -269.37 
Cash:11,132.36 
Total:28,489.78 


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Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.