Key Takeaways
1.Globalization is the spread of business activity (products, services and people) across international borders.
2.Potential benefits of globalization for the economy include increased choice, higher quality products, increased competition, economies of scale, increased capital flows, increased labor mobility and improved international relations.
3. For businesses, the advantages of globalization can include cost savings, international recruitment, specific market opportunities, and the spreading of risk.
4. Potential disadvantages of globalization for world economies include possible monopolization, structural unemployment, inter-dependence and tax avoidance.
5.Potential disadvantages of globalization for individual businesses include compliance, control and inadequate market knowledge.
6. Once the globalization decision has been made, there are a range of subsequent challenges for any business moving in this direction.
Globalization means a world without international borders. In this article, we delve into the definition of globalization, and explore the benefits of globalization for individual businesses, and economies as a whole. In addition, we look at some of the challenges of globalization for companies that choose go down that route.
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What is the definition of globalization?
In the broadest terms, globalization is the spread of products, services, people, and activities across national borders and across cultures. On an individual business level, this might be referred to as global oroverseas expansion. Sometimes it is used to refer to a more specific phenomenon in economics — the spread of “free market” policies across the world economy.
Thought of in this way, globalization is still a work-in-progress: For example, in some countries, there are trade sanctions in place which prevent economic engagement with other countries. But at the root of this concept is international trade. This is not a new phenomenon — it’s ancient, in fact. For example, the incense trade route between the southern Arabian peninsula and the Mediterranean began in roughly the 7th century BCE.
In the modern age, the terms of global trade are largely governed by agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) between eleven major Asia-Pacific countries, and the work of international organizations, such as the World Trade Organization. Through these agreements, countries usually agree to reduce import tariffs on goods which make the cost of importing those goods higher than they would otherwise be.
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Below we will consider some of the major advantages of globalization, both for an individual country’s economy, and for individual businesses. We also look at the challenges of globalization in the same way.
Chart: The globalization trend over time
In the chart below,from Fredrik Erixon at European Centre for International Political Economy (ECIPE), the barriers to globalization over time are made clear.
From a high point in around the year 2000, regulatory and other barriers to trade have been applied to place a break on globalization efforts.
What are the economic benefits of globalization?
As globalization is imperfect, and at various stages of implementation, it is hard to make a universal claim about its benefits. However, some of thepotentialbenefits of globalization to economies include:
1. Increased choice
No individual country could produce the sheer variety of goods that can be produced globally. Through globalization, consumers in one country can have access to goods and services that they would never otherwise have access to.
2. Higher quality goods
As each nation concentrates on its own specialty industries, there is far less ‘re-inventing the wheel’. For example, every country does not need to waste its scarce resources producing its own version of the smartphone when one can be imported from a country that specializes in this product.
3. Increased competition
The presence of increased competition in a country’s economy from foreign companies means a more efficient market and lower prices for consumers. Suppliers of goods and services need to keep their prices low to stay competitive.
4. Economies of scale
As globalization provides companies with a much bigger effective market in which to sell their goods, they can scale up their production. As the level of production increases, their margin on each good or service provided can increase as their fixed costs remain the same, or become incrementally smaller.
5. Increased capital flows
Capital is able to flow into developing economies providing a significant form of finance that businesses in that economy would not otherwise have access to.
6. Increased labor mobility
By allowing individual workers to move to other countries, the global economy can better match supply and demand. Countries that are excellent in educating certain professionals can export those professionals to other countries which do not have the same specialty. For example,New Zealandmust import a significant number of skilled agricultural workers every year to harvest its crops.
7. Improved international relations
Countries that have a positive trade relationship with each other, have an incentive not to get into conflict. On a global scale, this should reduce the likelihood of armed conflict between countries.
What are the benefits of globalization for individual businesses?
Putting aside the possible benefits of globalization for individual economies and the world economy as a whole, what are the potential benefits or advantages of globalization for individual companies.
1. Cost savings
By outsourcing certain functions, such as payroll and HR, to countries where this can be provided at a lower cost, an international enterprise can increase its overall profitability.
But globalization doesn’t just mean outsourcing: Setting up separate legal entities (such asforeign subsidiaries), branches, or usingGlobal PEO solutionscan be effective mechanisms for setting up a more cost-effective business location.
2. International recruitment
If you struggle tofind the right talentin your own country, an advantage of globalization is that you may be able to source workers in another country where there is significant capability in that area.
3. Specific market opportunities
You may have identified specific countries where there is anopportunity to corner the marketwith your product or service. Moving into that market can be an important growth opportunity for your business;
4. Spreading risk
Individual countries are vulnerable to economic events and fluctuations specific to that country. An advantage of globalization and expanding into multiple countries is that an enterprise can spread this risk and ensure that they don’t place “all their eggs in the same basket”.
What are the potential economic disadvantages of globalization?
While there are some clear benefits to globalization, there may also be costs associated with this for individual economies, depending on how it is implemented. Some of the challenges or disadvantages of globalization that have been identified include:
- Possible monopolization of multi-national companies
- Large enterprises from developed countries may move into smaller developing nations and take over the market. Their specialization and efficiency in providing a particular good or service may mean that local producers in a developing country are knocked out of the market;
- Structural unemployment
- If a country is no longer competitive in the production of a particular good, this may mean that its production rapidly moves offshore, and workers are left unemployed. While it may be possible to re-train these staff and deploy them to a more efficient market, this lag can take years, resulting in a significant rise in unemployment and inequality;
- Inter-dependence
- Individual countries become dependent on other nations for their supply chains. If there is a disruption to this chain, they may no longer be able to produce the good themselves
- Tax avoidance
- It may be that some companies are able to avoid paying taxes that one might expect that company to pay in a given country through legal tax arrangements.
- It is worth emphasizing that all these potential disadvantages are ones that apply to the economy as a whole, they are not costs for individual businesses.
What are the potential disadvantages of globalization for businesses?
While a global outlook is usually to the benefit of a business, there are a few potential disadvantages. These include:
- Compliance
- Individual businesses will often be less familiar with thecompliance environment overseasthan they are with the compliance environment in their own location. To mitigate this disadvantage it can be useful for businesses to engage a foreign partner who is an expert in local legal, tax, and compliance issues.
- Control
- While it may be possible for a business to operate directly in a foreign country (known as opening a branch office), this is not the most common method of international expansion. More commonly, the company opens a subsidiary or separate business entity which is no longer in the direct ‘chain of command’ of the original business.
- The lack of direct control of an overseas location of a business can lead to significant compliance, business, and reputational risks (this is discussed in greater detail in our article ‘Branch versus Subsidiary‘).
- Inadequate Market Knowledge
- Global expansion means understanding the market dynamics of eachcountry of expansion. Without in-depth knowledge of that market, it can be difficult to know whether it is an appropriate target country for a product or service.
Video: Pros and cons of globalization — Stiglitz speaks
World-renowned economist Joseph Stiglitz explores the benefits, the disadvantages and the challenges of globalization.
What are the challenges of globalization?
While the benefits are substantial, there are challenges which await any company that wishes to exploit the benefits of globalization. Those challenges, while managable, include:
1. The need for a legal presence
Many companies realize the vast opportunities that are available in new markets, but they usually do not have a legal entity in these countries.
This can be problematic because there are restrictions on the activities of companies who do not have a legal entity, such as a subsidiary, in the country of expansion. While the company may be able to incorporate a business in a new country, many business owners are hesitant to invest a substantial amount of money in a new endeavor when they do not know if their expansion will be successful
Even if they are willing to take on this risk, they may not have theresources availableto pay forlarge expenses, such asthe incorporation costs or paid-up capital requirements (for example, the most common form of incorporated entity in Germany, the ‘GmbH’, requires a minimum of €25,000 in paid-up capital.
Additionally, many countries require businesses to inject capital into a bank in that country that can only be used on business activities, which makes the prospect of setting up a separate entity cost-prohibitive for many businesses.
2. The difficulty of testing the market
Most prudent business owners realize that their product or service may not be embraced on a global scale with the same function and marketing information. Therefore, they invest inmarket researchto see how the potential market perceives their product and brand.
However, businesses that are overseas mayhave difficulty testing the market when they do not have a local presence.
Additionally, they may run afoul of complex regulations pertaining to foreign businesses. For example, sometimes advertising activities require that the business possesses a specific licence which can only be held by businesses registered in that country: Businesses will want to avoid issues with foreign bureaucratic agencies so that they are not later prohibited from conducting business in the country.
3. Hiring staff in a compliant manner
To have any type of expansion in a new country, key staff members will need to be in place.
However,many countries do not allow foreigners to hire staff without a legal entity in the country.Even if the company establishes a legal entity in the country or opens asales office,the employee’s activities may be restricted.
Additionally, many business leaders may not be familiar with foreign laws regarding employment law, tax,and other legal issues in that country.
4. Regulatory and legal compliance
Of course, businesses want to expand into another country without violating any laws or regulations. However, setting up operations in a foreign country can be complex, especially when business leaders do not speak the local language.The regulatory framework in foreign countries canalsooften be confusing for foreigners.
To comply withapplicableregulations in other countries, the business may need to perform the following tasks:
- Incorporate a business
- Register with tax authorities
- Open a corporate bank account
- Acquire necessary certifications
- Maintain corporate records and filings
- Register trademarks and other intellectual property
- Process payrolland administer employee compensation and benefits
Completing these tasks in a compliant manner can be a difficult undertaking for someone who is not an expert in the country’s regulatory scheme.
Explore the benefits of globalization with Horizons
While there is an ongoing debate on thepros and cons of globalizationfor individual nations, and the world economy, the benefits of expanding globally for individual businesses are clear.
Horizonsprovides international consulting and expansion services to support your globalization mission, and help you overcome the challenges of globalization. Our specialists can advise on tax, compliance, and legal issues and implement the outsourcingorstaffingsolutions that best suit your company.
Frequently asked questions
Economic benefits of globalization include increased consumer choice, higher quality products, economies of scale and increased capital flows into locations where it is needed most.
Not directly. For example, globalization means that it is not cost-effective for iPhones to be manufactured by a US business, compared to a Chinese manufacturer. In that case, globalization would not directly benefit the US business.
However, it is debatable and controversial whether globalization benefits everyone overall.
