If you haven’t already, you should read Calpundit’s interview with Paul Krugman. For regular readers of this blog, there’s nothing new – unsustainable Bush fiscal policies imply financial crisis partly by resolved by inflation, with a consequent increase in interest rates, frequent mention of Argentina etc. But Krugman says it better than I do, and Calpundit shows new possibilities for blogging with a rare instance of primary newsgathering.

This is the first second draft of my long-promised post on McDonalds and American soft power. I’ve had quite a few useful comments and have incorporate some, still digesting others. More comments much appreciated.

It’s hard to go anywhere in the world without running across American fast food chains like McDonalds and Starbucks, American movies and American sitcoms. This fact has led to lots of dubious inferences.

A particularly egregious example was Thomas Friedman’s Golden Arches Theory of Conflict Prevention, which held that no two countries with a McDonalds would ever fight a war. This theory was presented to the world in Friedman’s 2000 February 1999 bestseller The Lexus and the Olive Tree. A few months later, the USAF was bombing Belgrade, a city with seven McDonalds outlets.

More common than this kind of grand theorising are two inferences, one anti-American and one pro-American. More precisely, I should say “critical of/supportive of American economic and social institutions” since many of those who are most “anti-American” in this sense are domestic American social critics.

The anti-American inference is that America is a trashy and decadent society intent on forcing its low-grade way of life on to the rest of the world. One version of this inference is presented in Naomi Klein’s No Logo, though I’ve oversimplifed her message fairly drastically.

The pro-American inference is that the ubiquity of these American icons is evidence of American ‘soft power’ (a term coined by Joseph Nye in Foreign Policy in 1990) and proves that the rest of the world either loves and aspires to the American way of life or is jealous and hypocritically denounces Americanisation while secretly craving it. One version of this inference is presented by Fouad Adjami (link via Geoff Honnor). Again I’ve (over)simplified a complex argument to extract a central theme. Another reader (Ritu) mentions Fareed Zakaria in this context, raising the point that, in the current environment a Muslim-sounding name is probably an asset for someone writing in praise of American soft power.

Economists are generally suspicious of purely cultural accounts of economic outcomes, preferring to focus on technological issues such as factor endowments and on the effects of income and relative prices on demand patterns. This preference isn’t always right – cultural factors, industrial policies and pure chance have an important role to play – but it’s always worth considering the economic basics.

But there’s a standard economic analysis, dating back to the 1950s, that explains a lot about the prevalence of McDonalds without any need for a notion of ‘soft power’. Nicholas Gruen kindly sent me the following extract from one of his pieces, which I assume arose from debates over Australian car industry policy

In 1961, the economist Linder suggested that product specific scale economies and product differentiation combined with local tastes and transport costs to influence the pattern of trade in manufactures (1961: 87ff See also Kravis, I. B., (1956), “Availability and Other Influences on the Commodity Compositioin of Trade, Journal of Political Economy, Volume LXIV). In particular, he suggested that countries domestically manufacture differentiated products which can be manufactured at economic scale because they appeal to majority home market tastes. At the same time they import products to meet minority tastes. Minority tastes cannot be efficiently served from local manufacture because low levels of demand prevent local manufacturers achieving scale economies. Where these products meet majority tastes in other countries, they can be manufactured there at lower cost and then exported back to countries where they meet minority tastes. The resulting pattern of mass marketing at home and niche marketing abroad is well represented in many markets for manufacturers, not least the market for automobiles

Although I obviously picked up the ideas that were being tossed around during the car policy debate, I didn’t read the Kravis and Linder papers or maybe read them and forgot them [insert PJ O’Rourke drug allusion here] The Kravis-Linder model extends neatly to things like movies and McDonald’s franchises.

The most obvious common characteristic of chain restaurant franchises and movies is that of large fixed costs combined with effectively unlimited scale economies. A Hollywood movie can easily cost $100 million to make (the movie Titanic cost far more in real terms than the ship did), but once it’s made the cost of showing it is trivial. Similarly, a huge amount of expenditure goes into the creation of an instantly recognisable franchise like McDonalds or Starbucks, but the marginal cost of adding an extra outlet is relatively small. For brevity we’ll call both movies and franchise outlets “chain services”.

By contrast, the cost structure of an independent supplier, such as a coffee shop, restaurant or live entertainment venue is much flatter, and costs tend to increase beyond a certain size, rather than decreasing. On the other hand, the independent can tailor the product to a local market. The balance between independent local suppliers and chain services will depend on the amount of local variety or, conversely, on the homogeneity of the market as a whole.

It’s easy to see that the best market for which to produce a product of this kind is the biggest and most homogenous one, which, among the developed countries means America. Although America is not a homogenous society it’s at least as homogenous as any European country and about three times as large. So it’s not surprising that chain services have been most successful in America, to the extent that independent suppliers have been largely eliminated in many markets. Obviously, the optimal type and quality of services is that which matches the tastes of the average American consumer in the given market (which may be segmented but must be large).

Now think about similar markets in other countries. Chain services will be slower to develop, and less successful in competition with local independents because the potential market is smaller. This creates a opportunity for entry by American suppliers of chain services, whose fixed costs have already been paid in the American market, and who can therefore sell at lower prices.

An important consequence is that the market position of American chains is not the same in export markets as in America. Being designed for the American market, the product will not meet local tastes in export markets as closely, so it will be perceived as a low-quality, low-price product. This is most obvious with Starbucks, which is routinely used in America as a trope for luxury consumption (“Starbucks + upscale” gets 17600 hits on Google), while being regarded as distinctly second-rate in Australia. But even McDonalds has a noticeably higher status in America than in its overseas markets.

The big American chain service suppliers have tried to address this problem by tailoring their products more to foreign markets. But the more this is done, the less the cost advantages of multinational operation. Most attempts of this kind have been notably unsuccessful.

The same point applies to movies and particularly to TV, where the minimum efficient scale is lower. As soon as a country gets a big enough and rich enough market, and can establish its own TV industry, home-made shows (including local remakes of successful foreign shows) tend to take the top spots, while cheaper imports are used as filler. The US market is so big that the main networks almost invariably prefer a remake to the use of imported material.

What are the costs and benefits of all this. Obviously, Americans , considered as workers and investors, benefit from the fact that their scale economies give them cost advantages in markets for films, franchise production and so on.

This partly comes at the expense of other exporters. In talking about American ‘soft power’, it’s not often noted that, with some important exceptions such as computers, it’s rare nowadays to encounter American manufactured products outside the US. Looking around my house there’s a French car, some German whitegoods, and heaps of things made in Japan, East and Southeast Asia and even Australia. The only items that are obviously American are the Powerbook and its predecessors, and even they were mostly made in Singapore.

The effects on American consumers are ambiguous, but arguably negative on balance. Although they benefit from having films and chain restaurants tailored precisely to their tastes, they have far fewer alternatives than before the rise of the chains, particularly if their tastes differ a bit from the mean.

By contrast, precisely because the chain product is rather less attractive, consumers in markets outside the US tend to keep alternatives in existence. One of the traps for writers on ‘soft power’ is that, observing the proliferation of McDonalds, Starbucks and so on, they imagine that everyone in the countries they visit is a customer of these enterprises. This is, roughly speaking, true in the US, but the market share for these chains is smaller everywhere else.

A closely parallel analysis applies to language (thanks to Jack Strocchi for raising this point). There are big economies of scale and, as the language with the most (income-weighted) native speakers, English has a natural comparative advantage. So the natural outcome is one where English monoglots can make themselves understood almost anywhere, while non-native speakers of English who wish to function in the global economy must be, at a minimum, bilingual. If, as seems likely, bilinguality has cognitive benefits, as well as the obvious cost of learning a second language, the welfare effects have the same sort of ambiguity as McDonalds – the monoglots have lower cost and more convenience but less variety. [An interesting countertrend to all this is the rise of Spanish in the United States itself – to the point where native English speakers like George and Jeb Bush find it useful to be at least partly bilingual]

Even though a purely cost-based analysis works pretty well, it would be silly to dismiss ‘soft power’ altogether. Clearly, American movies and products do better at times and in places where the American way of life is viewed as cool and desirable. But relative prices are probably more important. Korean cars sell like hotcakes in Australia, but that doesn’t mean that the average Australian wants to move there.

Similarly, American movies sell well because economies of size mean they can have big budgets, and therefore, top-quality special effects and cinematography. That doesn’t mean that the average moviegoer or TV-watcher has any particular opinion about American foreign policy or social structure.

Less sophisticated audiences may be led to assume that the average American has the upper-middle class living standard typically presented in these productions. On the other hand, for middle-class consumers in developed countries, exposure to McDonalds and Starbucks leads to the equally misleading inference that American living standards are far below those prevailing in their own countries.

Like most people, I suspect, I find the details of international trade negotiations eyeglazingly boring. So, I was as surprised as anybody when the WTO meetings in Cancun suddenly collapsed, with less developed countries walking out en masse.

The immediate cause seems to have been the fact that the meetings focused on liberalised investment rules (pushed by the Europeans) while the poor countries wanted to talk about agricultural barriers and to have their proposal treated equally with a joint EU/US offer.

The underlying cause, in my view, is that the WTO now lacks a real backer, that is, a rich and powerful country or group of countries who want it to play a central role. The UN is backed by the Europeans, the IMF (with occasional qualms) by the US and the World Bank by both. Until recently, the WTO had the backing of the US which was historically the world’s biggest exporter and stood to gain a lot from expanded trade.

But now the US has switched to a strategy of bilateral negotiations like the proposed FTA with Australia where it can extract better terms. Moreover, like most net importers, the US is becoming more protectionist as its trade deficits build up.

Finally, the aggressive overreach by the WTO itself (things like the tuna-dolphin decision, that led to the Seattle explosion a few years ago means that the organisation has few real friends among NGOs and the broader public.

Given that, in the dispute over US steel tariffs, the WTO is bound to rule against the US, and the US seems unlikely to back down, it’s conceivable, though still improbable, that the organisation could collapse completely in the next few years.