The Twilight of Sovereignty: How the Information Revolution is Transforming Our World

Wriston, Walter B.


Chapter Five

The End of Trade

Chapter Five

The End of Trade



No nation was ever ruined by trade.

Benjamin Franklin

THROUGHOUT HISTORY A DISPUTE HAS RAGED ABOUT THE way to achieve economic progress. Thucydides, the great historian of the Peloponnesian Wars, understood clearly the role of trade in the fifth century B.C.:

Without commerce, without freedom of communication either by land or sea, cultivating no more of their territory than the exigencies of life required, (people) could never rise above nomadic life and consequently neither built large cities nor attended to any other form of greatness.

But the concept that trade produces human progress and the lack of it condemns people to mere subsistence has not been universally shared. This ancient animosity toward trade and commerce as a way to increase the wealth of nations dies hard, and until the eighteenth century the free flow of trade was seldom seen as advantageous.

The maps we look at today and the trading relationships that we now take for granted bear little resemblance to those


we knew a generation ago. For example, what we now know as Germany consisted only two hundred years ago of over a thousand economic units separated by customs barriers and guild regulations. While the Germans were still living in commercial isolation from one another, the United Kingdom had long been a common market. Martin Wolf has written:

This difference was one of the main reasons why the Industrial Revolution started here, the significance of the internal barriers being shown by the great rapidity with which the German economy caught up, once a custom union (the Zollverein) had been put in place during the nineteenth century.[31] 

The United States enjoyed a similar advantage. Shortly after Chief Justice Burger retired, I asked him what he regarded as the most important sections of the U.S. Constitution and he answered immediately, "The first Amendment and the commerce clause." The latter, he explained, made possible our continental common market, which created the circumstances for America's economic growth.

For hundreds of years the world has been torn between the extremes of economic nationalism and the concept of worldwide free trade, a debate that raises the most serious questions concerning the state's power and wealth, to say nothing of its fundamental purpose. The case for free markets, according to F. A. Hayek, is that

the market is the only known method of providing information enabling individuals to judge comparative advantages of different uses of resources of which they have no immediate knowledge and through whose use, whether they so intend or not, they serve the needs of distant unknown individuals. This dispersed knowledge is dispersed, and cannot possible be gathered together and conveyed to an authority charged with the task of deliberately creating order.[32] 

The mercantile system of the sixteenth, seventeenth, and eighteenth centuries, on the contrary, was a political endeavor to maintain and extend the power of government not only abroad but at home by attempting to regulate all kinds of production -- a concept that bordered on absurdity when Jean-Baptiste Colbert, Louis XIV's controller general, decreed even the size of a handkerchief and the length of a fish that could come to market. According to Colbert: "All purchases must be made in France, rather than in foreign countries, even if the goods should be a little poorer and a little more expensive, because if the money does not go out to the realm, the advantage to the state is double." Although mercantilism, like most political concepts, was variously expressed by many people, the central point of mercantilism was a belief that "the greatness of a state is measured entirely by the quantity of silver it possesses."[33]  The purpose of the state, in other words, was primarily to enrich the royal treasury, not to enhance commerce or encourage the division of labor.

To further this goal, the object of the mercantilistic game was to export goods abroad and import precious metals in payment. The gold and silver thus acquired, so the argument ran, paid for the armies and navies that fought and won the wars that increased the territory and power of the state. Soldiers and sailors at that time put little faith in the promises of kings and demanded gold in payment for their services and later only reluctantly accepted silver. So gold was necessary to maintain an army, and selling goods abroad for bullion was one way to produce it.

In 1776, Adam Smith, as we have seen, challenged the principles of the mercantilistic system, arguing for freer trade and laissez-faire. Smith also argued that the wealth of a country was directly connected to "the increase of the number of its inhabitants" rather than the size of its gold reserves. Smith saw that the size of the market was central to his concept of the division of labor, although in his wildest dreams he could never have contemplated today's global market.


As usual, he put it succinctly: "As it is the power of exchanging that gives occasion to the division of labor, so the extent of this division must always be limited by the extent of that power or, in other words, by the extent of the market."[34] 

The power of sovereign states to control the commerce between its citizens with citizens of other nations has been a jealously guarded right as long as nation-states have existed. From before the time of Adam Smith, national governments understood that to control a nation's economy, to advance one particular goal or frustrate that one, to help this group at the expense of another, to reward friends and punish enemies, states must control international trade. They must, that is, assert the power if the state over that of their citizens to decide which deals get done, which foreign companies are tolerated, and which national ones are promoted.

Today this traditional sovereign power is eroding almost as rapidly as the power of individual states to control the short-term fluctuations in the value of their own currencies. It is eroding largely because the classic concept of international trade is becoming obsolete. The traditional multinational economy in which "products" are exported is being replaced by a truly global one in which value is added in several countries. The traditional business of import and export among nations is being replaced by a transnational system of product development, design, production, and marketing that takes less and less notice of national borders and which national governments can disrupt only at the risk of economic chaos far greater than the protectionist disasters of the past. The world has been moving, fitfully and with many reversals, toward a global economy almost from the beginning of time. But this process has accelerated enormously in the past few decades largely because the growing global information network, global financial markets, and improvements in transportation have greatly eased the difficulties of international trade and production. This information infrastructure has also encouraged consumers and businesses worldwide to de-


mand the same sorts of products at the best prices and quality, requirements that can be met only by access to a global market. We have not yet arrived at the point where government policy has shifted from protecting its natural-resources base from foreign capital and has moved toward policies that assure their citizens access to the best products at the lowest prices. But consumers are already demanding such a shift in many countries of the world because they are learning more and more about the world's goods as displayed on television.

This acceleration toward a global economy has produced a fundamental change in the world's work. The driving force behind that change is information technology and in particular the relative importance of intellectual capital in relation to physical capital. Intellectual capital -- human intelligence -- is now the dominant factor of production, and the world's most fundamentally important market is the market for intellectual capital. The most mobile of all forms of capital will be increasingly intolerant of nationalist restrictions because it is inherently global and almost immune from nationalist restrictions. Far more than any other form of capital, intellectual capital will go where it is wanted, stay where it is well treated, and multiply where it is allowed to earn the greatest return. Nations that respect the freedom of intellectual capital and accommodate it accordingly will prosper in the global economy. Those that imagine that this most powerful form of capital can be enslaved or entailed will wither.

For roughly the entire history of the industrial era annual growth in international trade has outstripped yearly GNP (gross national product) growth for the advanced economies, the only exception being the years between 1914 and 1950 when two world wars and an outbreak of protectionism interrupted the peaceful growth of world prosperity.[35]  In the past three decades, however, world trade has grown particularly rapidly despite a recent slowdown in the world economy and occasional outbreaks of protectionism -- mostly in the form


of nontariff barriers, such as national buying policies and import quotas.[36] 

From 1950 to 1985, while real world GNP tripled, world trade grew sevenfold. America's merchandise exports more than doubled in the decade ending in 1987, from $120,816 million to $249,570 million.[37]  Among the Western industrial powers the percentage of GNP absorbed by foreign trade has almost doubled since 1960.[38]  In the United States, which has the world's largest internal market, foreign trade has, until recently, represented an almost insignificant single-digit percentage of our national efforts. But by the mid-1980s, merchandise imports and exports accounted for over 15 percent of U.S. GDP (gross domestic product). In Europe, with their far smaller internal markets, the figures were even more arresting: By 1986, merchandise trade accounted for more than 20 percent of France's GNP, more than 40 percent of Great Britain's and almost 50 percent of West Germany's.[39]  The creation of the European Economic Community (EEC) was therefore a foregone conclusion, and the complete integration of the European nations will increase these numbers even further.

Yet none of these figures count trade in services, the most rapidly growing sector of world trade. The reason for the absence of service figures is partly historical and partly practical. For years, government statisticians used the cash, insurance, and freight (CIF) method in value the goods sold in international trade, thus incorporating these services in the value of merchandise trade. Only a few years ago, the model economists built of the world economy did not have to account for services, but now such models are unacceptable; shipping companies, airlines, travel companies, financial institutions, consulting firms, accountants, and lawyers are all engaged in this kind of service trade. The importance of trade in services was recognized on September 20, 1986, when trade ministers from all over the world, meet-


ing in Punta del Este, Uruguay, agreed for the first time to make trade in services a major issue in GATT (General Agreement on Tariffs and Trade) negotiations. Nor do the trade numbers include the huge movement of money capital that by far exceeds world trade. Many of these transactions can only be effected by buying or selling foreign exchange, so the size of this market had to expand and is now probably about $500 billion per day and growing. While these numbers are tricky in that they may include double counting between institutions, they nevertheless indicate a market of a size, depth, and speed never before seen on earth, one that presents entirely new problems for sovereign states.

It used to be that each sovereign policed and regulated the markets operating in its own country with small regard to what was happening elsewhere. Each country has its own clearance system by which trades are settled, each its own rules of trading, its own margin requirements and trading hours and holidays. Even though markets are now blips on a screen, and not geographic locations, sovereigns try to protect and control that part of the market that functions within its jurisdiction. Yet even this becomes increasingly difficult, for if one sovereign becomes unreasonable in the severity of regulatory demands, the market node in that country withers and is replaced by the node "residing" in more hospitable climes. To be effective, a sovereign must therefore cooperate with other governments in forging international agreements.

This problem was acknowledged officially by the Bank for International Settlements -- a kind of a central bank's bank -- in a study released in March 1989, which concluded that "the appropriate division and sharing of supervisory responsibilities will be extremely problematic."

While creating massive problems for government regulation, the electronic market occasionally solves problems by eliminating geography. The fierce rivalries that have split stock trading among seven regional exchanges in the tiny


country of Switzerland prevented the opening of a Swiss futures and options exchange because no city would tolerate its location in any other. In the meantime, the business was going to London and Amsterdam. Saul Hansell tells us: "The solution was to redefine an exchange. The...Swiss Options and Financial Futures Exchange is not in Geneva nor Zurich nor any other city; trading occurs in the dimensionless geography of a computer network."[40] 

The enormous explosion of world trade has not only created a global market, but the worldwide information network has made it possible to carry the division of labor through all stages of production and marketing, with value added in many countries. An item in the showroom with a well-known brand name like IBM may in fact be only a handsome facade hiding parts from all over the world. The popular IBM PS/2 Model 30-286, for example, contains a microprocessor from Malaysia, oscillators from either France or Singapore, disk controller logic array, diskette controller, ROM and video graphics array from Japan, VLSI circuits and video digital-to-analog converter from Korea, and Dram from Singapore, Japan, or Korea -- and all this is put together in Florida. To complicate matters further, some components are manufactured overseas, but by a U.S. company.[41]  Since there are thousands of products put together in similar ways, the old concept of trading one item for another is obsolete. But the bookkeeping system to record these international transactions has not changed. When measuring systems fail to keep up with technology, they become less and less useful, and through them we understand less and less about the world economy.

The current trade accounting system is totally inadequate to produce any useful numbers for policymakers concerning the following transaction: An American author exports intellectual capital in the form of a manuscript to Taiwan where it is printed and bound into a book. The book is then shipped back to the United States to be sold in bookstores


here. The export of the manuscript, which from a physical standpoint is small, barely shows in tallying up U.S. exports but, the finished book at, say, two dollars per copy shows up as part of the value of Taiwan's exports. The books are sold in this country for thirty dollars by American stores, and royalties accrue to an American author. So far as the balance-of-trade figures are concerned, Taiwan runs a trade surplus with the United States, and we have a trade deficit with Taiwan. Clearly this accounting does not reflect reality, since the lion's share of the return on this capital is generated in the United States. These trends toward horizontal integration are being driven by the growing awareness that to survive in the global market, everyone has to go back to basics and pursue a form of comparative advantage. In this example, Taiwan did have such an advantage in actually printing and binding books, but the United States had the advantages of creating both the intellectual capital and the marketing strategy.

As the volume of world trade increases, so does the complexity of trade patterns and the number of significant players. Long dominated by the Developed Market Economies, essentially Western Europe, the United States, and Japan, the club of major trading nations is growing quickly.

Since 1965, the developing countries' share of world manufactured exports has risen from 7.3 to more than 17 percent. Most of this increase is due to such newly industrialized countries (NICs), as Hong Kong, South Korea, Singapore, and Brazil, all of which now rank among the top twenty exporters of manufactured goods, though no developing country ranked among the top thirty as recently as 1965.[42]  India, Indonesia, and others are coming on quickly. Several of these countries -- Korea is a particularly strong example -- have become driving forces in regional development. With growing prosperity and rising wages at home, such companies have begun to move labor-intensive manufacturing jobs to their less developed neighbors, and in turn have helped those lesser developed


neighbors become more important markets for NIC manufacturers.

Among the developed countries and NICs, the exchange of products has become more egalitarian, making the warp and woof of trade more complex and difficult to unravel. In the first post-World War II decades, the United States thoroughly dominated the sale of high- and mid-technology products; world trade patterns in such products resembled the spokes of a wheel of which the United States was the hub. As recently as the late 1960s, Japanese cars were regarded with amusement, and "made in Japan" (or Hong Kong) were bywords for inferiority. Today all the developed countries and most of the NICs can produce a vast number of products and components that approach state of the art. As a result, trade flows of sophisticated products move from country to country for value-added components, assembly and packaging.

Much of this trade, particularly in information-rich technologies, is carried on within or facilitated by, an increasingly complex network of alliances between companies sharing precious technological and intellectual resources. This sharing of intellectual capital may take the form of jointly developed products, filling in each other's product lines, supplying each other's cutting-edge components, or simply availing themselves of the best and the latest in today's blisteringly fast technological competition. With technology and manufacturing capabilities so widespread, the international sourcing of competitively priced components is no longer a luxury but a necessity from which no country's businesses can afford to be cut off. As Christopher Bartlett of the Harvard Business School has written, "competitiveness is already beyond the reach of the purely national company."[43] 

The year 1989 marked the tenth anniversary of the world's largest producer of commercial jet engines, a company that hardly anyone outside the industry has heard of. The company, CFM International, is a joint venture of SNECMA (a French government company) and GE, which is,


of course, a private American company. This new entity is managed jointly by a third company called CFMI. The official press release of July 18, 1989, celebrating the anniversary, explained the workings of an enterprise that has produced two thousand jet engines with three thousand more on order.

CFMI has a small staff to act as project manager and as the contractual interface with customers. But CFMI does none of the engineering, manufacturing, marketing, or project support work itself. It buys that work from SNECMA and GE, balancing the work shares so that they reflect the 50/50 ownership of the program. CFMI also splits the sales revenues between the two parents.

This complex but highly efficient structure was constructed to help fulfill the French government's desire to enlarge its role in the world market for commercial aircraft engines and GE's desire to sell two of its new aircraft engine designs to Airbus Industries, a European consortium, which was going to build a new 150-passenger airliner. The technology of the engine core, which is built by GE in Cincinnati, Ohio, is not shared with the French partners due to restrictions mandated by the U.S. government. But the French have significant technologies that are likewise hidden from the Americans. While the engine cores come from America, SNECMA builds the low-pressure outer parts of the engine in France. Some engines are assembled in GE's plant in Evendale, Ohio, and some in SNECMA's facility in Villaroche, France. The engines are sold all over the world to civilian airlines and also to power more than three hundred military aircraft in six countries.

This very successful international venture is only one example of why it is becoming more and more difficult to unscramble the egg as global manufacturing and marketing alliances are becoming the rule rather than the exception. Nevertheless, protectionism has had its effects: a good deal of trade has been transferred into foreign investment, as com-


panies avoid quotas and other nontariff barriers by assembling or producing final products in the countries in which they mean to sell them. Thus, Honda now builds more cars in America than in Japan. Roughly half of American chemical workers work for foreign-owned companies.[44] ) In 1987, some thirteen hundred American and European companies made and sold over $260 billion worth of goods in Japan, accounting for 10.9 percent of Japan's GNP.[45]  But this trend, not all of which is due to protectionism, only strengthens the global economy and make it more difficult for economic nationalists to control or subvert it by substituting products made locally by foreign companies.

This expanding pattern of world trade in goods is largely a function of information technology, for not only has the global telecom network made global enterprise far more practical; products become easier and more profitable to trade as information becomes the dominant source of value added. A few ounces of microchips or a few pounds of VCRs may earn more profit than a ton or steel, though steel itself is made by an information-rich new system that today packs more strength and value per pound than it did a decade ago. The cost of moving high-technology products around the world is now such an insignificant percentage of their selling price that a growing percentage of such products travels air freight. So cross-border business agreements are limited not by cost so much as by the imagination of the participants. For example, one division of the General Electric, Power Systems, has sixteen alliances with sixty-two companies located in nineteen countries. These types of arrangements are becoming typical of all large companies, no matter where their headquarters may be located.

The automobile business is a classic example of alliances covering everything from engineering to production. Chrysler, for example, owns 24 percent of Mitsubishi Motors, which in turn owns part of the South Korean company, Hyundai. Additionally, automobiles bearing the Chrysler logo are made


by Mitsubishi, and a fifty-fifty joint venture of the companies in Illinois will be producing cars under both nameplates. Ford owns 25 percent of Mazda, and Mazda makes cars in America for Ford, and Ford makes trucks for Mazda. Each one of these companies owns a piece of Korea's Kia Motors. Ford and Nissan swap vehicles in Australia, while Ford and Volkswagen are a single company in Latin America that exports trucks to the United States. General Motors owns 41 percent of Isuzu, which is starting a joint venture in America with Subaru, which in turn is partly owned by Nissan.[46]  And so it goes. Europe is also full of such alliances, which grow in number and complexity every day. These ventures range from relatively arm's length relationships, such as licensing and outsourcing, to more formal "alliances," consortia, joint ventures, and mergers.

During the 1980s, high-technology firms, such as Siemens (FRG), Philips (Benelux), GGE, Bull, and Thomson (France), Olivetti (Italy), AT&T, IBM, Control Data, Fujitsu, Toshiba, and NEC (Japan), each forged numerous foreign alliances; some of them formed dozens.[47]  A chart of Siemens's international cooperative agreements is a genealogist's delight, including, among others, Ericsson, Toshiba, Fujitsu, Fuji, GTE, Corning Glass, Intel, Xerox, KTM, Philips, B.E., GEC, Thomson, Microsoft, and World Logic Systems. IBM has so many alliances in Japan that there is a Japanese book on the subject called .

The driving force behind all these combinations is the need to make the most out of increasingly precious and highly mobile intellectual capital. Research and Development (intellectual capital investment) has become a huge fixed cost for many high- (and medium-) technology companies. A new drug may cost $300 million to develop, a new jet engine, a billion. Moreover, the pace of technological development means that even a highly successful R & D effort may in the end not come up with a state-of-the-art product but, rather, with an expensive also-ran.

While politicians still talk of international trade and a few industrialists echo their statements, the integration of the world's production is destroying the reason that a balance-of-merchandise trade should exist between countries. The trade deficit that was supposed to destroy America did not for the reasons we have mentioned. It can be argued that the very concept of a trade balance is an artifact from a bygone age. As long as capital -- both human and money -- can move freely toward opportunity, trade will not balance; indeed, one will have as little reason to desire such accounting symmetry between nations as between, say, New York State with California. We have built the beginnings of what George Gilder has called a "planetary utility."

The most remarkable example of economic integration, on a regional basis, is the rapid progress being made by the EEC toward turning Europe into a single market. There will continue to be setbacks along the way, some serious, but nevertheless remarkable progress is being made. The EEC was formally established in 1958 as an outgrowth of an earlier effort to form the European Coal and Steel Community. After languishing in the backwaters of national politics for years, the explosive growth of the world economy focused attention on the attractiveness of a huge integrated market in Europe, and a target date of 1992 was set to achieve it. By that date, the EEC nations intend to have dramatically eased the movement of people, goods, and money across national borders, harmonized thousands of national regulations and more than a hundred thousand technical standards; sweep away onerous barriers to trade and entry, and lower the costs of doing business throughout the community.

This effort is remarkable first because the single most common argument one hears for it is that European companies need guaranteed access to a much larger market than that afforded by their home countries if they are to support the development of information-rich products.

The other remarkable thing about the pursuit of the single


market is that a new generation of European business leaders has not waited for the political process to adjust to the information age but have sought to adjust it. The single market is more advanced in fact than in law, as business practice has outpaced legal reform. The armies of civil servants who stamp entry documents and compute border taxes are understandably not enthusiastic about seeing their jobs eliminated.

Clearly, a common currency will be the final step in a completely integrated market, and the EEC has moved toward this eventuality, but this surrender of sovereignty touches the very heart of the nation-state. To lose control of the right to issue currency is an attack against one of sovereignty's most valued rights. As trade between European countries grew, as business alliances proliferated, and as money capital was needed from wherever savings existed, the need arose for a unit of account that would be relatively immune from the changing relationships among national currency values. Several ideas were put forth, but most centered on some kind of a basket of currencies so that no particular devaluation or reevaluation would overwhelm the rest. After a few false starts, the European Currency Unit (ECU) emerged as the market's way to solve a problem. The ECU looks like a currency and is used like a currency, but it lacks one essential element, and that is the backing of some national or international monetary authority. The matter is further complicated by the fact that about the same time as the market was creating the ECU, governments were establishing a similar unit with the same name created by the European monetary authorities through swaps with the European central banks. These institutions thus become obligated to exchange 20 percent of their gold and dollar reserves for official ECUs. These official ECUs are not convertible into any single currency and cannot be traded. Additionally, the failure to establish a European monetary fund has given these official ECUs a certain


fragility that has prevented it from emerging as a reserve currency. The private ECU, on the other hand, which grew up in response to market demand, is growing in usefulness all the time. Corporations are using the ECU for denominating notes, bonds, and accounting entries. In 1989, there were 114 bond issues totaling 11.2 billion ECUs, up from 71 issues for 6.6 billion in 1987. The percentage of bonds issued in ECUs as against all bond issues stayed steady at about 4 percent. There has also been put in place an ECU clearing system that handles billions of ECUs a day and has become a vital part of the new, emerging European system. Today, more than five hundred banks lend, take deposits, and deal in the private ECU in the same way they handle any other currency. Some governments have even used the private ECU in their money raising efforts in Europe. The Japanese government, for example, guaranteed an issue of Japanese highway bonds in 1987 denominated in ECUs. What has happened, in effect, is that the governments, by not moving quickly enough to establish a usable common currency, have been bypassed by the market, which has created its own international currency, albeit of limited utility. Although not accepted as legal tender by any European government, the ECU grows in importance every year, since more companies need a stable European unit of account for cross-border contracts and a simpler and more accurate way to report the fortunes of pan-European businesses. The official movement toward creating a common currency in the EC (European Community) was given impetus at the meeting of ministers held in Holland in late 1991, but in the meantime private ECU is serving a very useful purpose.

The single market comes at a real cost in traditional national power and sovereign prerogatives: Brussels, where the European Commission and the European Parliament are located, now entertains more lobbyists than any city in the world other than Washington, testimony to how much power


has shifted towards this transsovereign body. But this shift in power, though guided by European leaders of admirable vision and leadership, came largely in response to economic and social forces, which in turn were driven by the information technology that made Europe into a de facto common market long before the national governments might have wished.


[31] Martin Wolf, Briefing paper for Manhattan Institute presented on April 24, 1989.

[32] F.A. Hayek, The Fatal Conceit (Chicago: The University of Chicago Press, 1988), p. 77.

[33] C.W. Cole, Colbert and a Century of French Mercantilism (New York: Columbia University Press, 1939), p. 337.

[34] Robert F. Heibroner, ed., The Essential Adam Smith (New York: W.W. Norton, 1986), p. 171.

[35] Richard Kirkland, Jr., "Entering a New Age of Boundless Competition," Fortune, 14 March 1988, p. 41.

[36] Transnational Corporations in World Development: Trends and Prospects (New York: United Nations Center on Transnational Corporations, United Nations, 1988), p. 20.

[37] Economic Report of the President (Washington, D.C.: U.S. Government Printing Office, January 1989), p. 424.

[38] Kirkland, "Boundless Competition," p. 17.

[39] New York Times, Report of numbers released by central banks, 14 September 1989.

[40] Saul Hansell, "The Wild, Wired World of Electronic Exchanges," Institutional Investor, September 1989, p. 91.

[41] Information from IBM. A letter dated November 10, 1989, signed by D.S. Hager.

[42] Kirkland, "Boundless Competition," p. 41.

[43] Quoted in Kirkland, "Boundless Competition," p.40.

[44] Ibid., p. 40.

[45] Kenichi Ohmae, The Borderless World (New York: HarperBusiness, 1990), p. 141.

[46] Information from an article by Charles R. Morris, "The Coming Global Boom," The Atlantic Monthly, October 1989.

[47] Transnational Corporations, p. 56. In some cases these alliances included some aspects of the traditional joint venture, as many alliances do.