August 09, 2020

Globalization related polices lead to freer trade and greater factor mobility. In an idealized world , absent transportation costs , differences in prices will be arbitraged away. This brings us to the first insight. If rates of returns are equalized the convergence of factor returns means that there is no advantage to location-based investing . That is investing in the US yield the same returns and international investing. If adjustment is costly, the convergence will not be instantaneous. It will take time. But for the lower income countries to converge in the long run to the wealthier countries’ income level is for the poorer lower income countries to grow faster . Thus, as trade barriers decline ,one should invest in the poorer lower income countries . The data in Table 2 shows that during the post WWII period , the lower income grew faster.as expected. Another example is the EU , who did the best during the early years? the PIIGS. Transportation costs , broadly defined, introduce a moat between an economy and the rest of the world. This allows for divergences in rates of returns across borders, as long as they are smaller than the transportation costs. These differences in rates of return are attributable to the local industrial policies that favor politically powerful special interest groups. Although convergence will be observed, full convergence will never be achieved . The transportation costs will prevent it. Hence as long as there is a moat, the country effect will matter somewhat. The greater the moat the greater the country effect and the more important global investing becomes.

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