GLOBALIZATION AND INEQUALITY: A CRITICAL ANALYSIS.
Abstract
The literature on globalization and inequality is vast and often polarized. One thing, however, that most scholars and commentators agree upon is that we live in an unequal world in which indicators of inequality abound, not only between nations but also within societies – “The world’s richest 500 individuals have a combined income greater than that of the poorest 416 million…. Real wages for most U.S. workers have increased little if at all since the early 1970s, but wages for the top 1 percent of earners have risen 165 percent.” The recent past has also seen a rapid economic globalization, characterized by the supranational spatial integration of economies and societies. The progressive interdependence of economies has intensified the flow of goods, capital, people, information and ideas around the world. The scope and depth of these flows have reshaped the world order and new institutions and configurations of power have sprung up in the place of the previous structures associated with nation-states. In the new world-order, international trade has grown five times in real terms since 1980. Consumers are the greatest gainers from globalization: they benefit from a wider choice of products and services at lower prices. In an average country, people would lose 28% of their purchasing power if borders were closed to trade. The poorest 10% of consumers, who buy relatively more imported goods, would lose up to 63% of their buying power. This period of economic integration has also coincided with a very steep drop in world poverty. The share of the world population living in absolute poverty has fallen from 44% in 1981 to 9.6% in 2015.
Introduction
My initial thesis is “Globalization has reduced inequality.” This essay is an effort evaluate the strength of this statement and understand the link between globalization and inequality, both at a theoretical and practical level. Understanding the nature of and linkages between globalization and inequality is critical. Unequal access to needs such as food, shelter and water abound and disparities in all of these realms pose challenges to human security and environmental sustainability.
1. ECONOMIC THEORY
There is ample economic theory that supports that integration of economies increases the average income of countries and reduces inequality. One of the most prominent theories championed by proponents of globalization is the concept of comparative advantage between countries proposed by 19th century British economist David Ricardo. Ricardo wrote: “Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each (…) By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically.” The idea here is simple and intuitive. Nations should focus solely on those industries in which they are the “most best” or “least worse” compared to other countries. A nation that trades for goods it can get at a lower opportunity cost from another country is better off than if it had produced it at home Ricardo observed. In this way, both countries may gain from trade. He thus concludes that industry specialization and international trade could always make countries richer overall.
Another prominent model is the Solow model developed in the 1960s by the American economist Robert Merton Solow. His theory argues that economies are poor because their workers have access to less capital. This shortfall in capital implies that capital should flow from rich countries to poor ones, attracted by a higher rate of return. The model predicts that the flow of capital ultimately leads both rich and poor countries to converge in the long-run to similar levels of productivity and income. Solow addressed the fact that rich countries would themselves be growing by reckoning that technology, driving growth in rich countries, could be adopted by poor ones. Indeed, he concludes that poor countries could learn from “rich countries’ mistakes” and leapfrog directly to more productive technologies.
From a theoretical standpoint, uninhibited trade and the free flow of capital and technology – the undercurrents of globalization – reduces inequality between countries through economic convergence. Poor nations catch up with rich ones in the long-run closing the global income gap. The natural next question is whether economic theory is relevant on a practical level. Looking at whether there is any empirical evidence supporting such predictions should help shed some insights on the question.
2. EMPIRICAL EVIDENCE
The Solow model seems to apply well enough to the history of rich countries. For instance, British GDP per capita soared past that of other countries in the 19th century thanks to the Industrial Revolution. By 1870, Britons were 30% more productive than Americans and 70% more productive than Germans. As the Industrial Revolution intensified and some countries pulled ahead, the income distribution between countries widened. As predicted by the Solow model, the gap eventually closed as rivals “improved upon Britain’s successes” and adopted its new ways of doing things more productively. By the early 20th century most of western Europe had caught up.
From the 1960s, to 2008 a similar process occurred at a global scale. As communications got cheaper and transportation got faster, developing countries were catching up with their rich-country counterparts. The average rate of growth of emerging economies was 7.6% over that period, 4.5 percentage points higher than the rate seen in rich countries. The emerging world was growing faster than the rich world and because of that difference, the income gap between the two worlds narrowed rapidly over that period.
However, a World Bank study published in 2014 suggests that convergence has slowed down a lot. Since 2008, emerging countries’ growth rates have been falling back and slipped down to the rates of growth of advanced economies. The average GDP per capita in the emerging countries grew just 2.6 percentage points faster than American per capita GDP in 2013 and only 0.39 percentage points in 2014. At that pace, convergence with the rich world occurs “more over a century than a generation.”
While the emerging world en masse has experienced economic convergence with the developed economies, differences within the emerging world persist. Economic growth since the 1960s has lifted many developing countries from a low-income to a middle-income level, but only a few countries have been able to catch up with advanced economies in per capita terms and stay there. In fact, most developing countries since 1960 have remained at a constant low-income level relative to the US. Only Honk-Kong, Singapore, Taiwan and Ireland experienced rapid and persistent relative income growth from the late 1960s all through the 2000s and have caught up with the higher level of per capita income of the US. Convergence means that income growth in these economies was significantly faster than in the US.
In sharp contrast, per capita income remained constant at 10% to 30% of the US level in Latin America. This group of countries remained stuck at a middle-income level. Lack of convergence is even more striking in low-income countries. For instance, Bangladesh, El Salvador and Mozambique have seen their per capita income remain at or below 5% that of the US level. Although these economies have grown in absolute terms, they have not grown at a rate faster than the US. Therefore, relative income levels have not changed. This phenomenon, of widening income gaps in the future notwithstanding the presence of higher growth rates in the poor countries today is what Homer-Dixon calls “the dirty little secret of development economics.”
Globalization, the main driver of convergence, has thus an uneven track record of
reducing global inequality and has been inconstant across nations. Some countries have
remained stagnant in relative income levels while some have been able to continue growing
faster than the developed nations to achieve convergence.
Nobel-prize winner economist Milton Friedman famously argued that the “world is flat.”
He meant that countries around the world could equally compete for “global knowledge as never
before” through new Web-enabled technologies. Others argue otherwise. The world is not in fact
flat. Some entire countries and many people are “stuck in deep craters that mar the global
landscape.” Critics claim that the fundamental challenge of the increasing reach of global markets
are that they are “inherently disequalizing”, making rising inequality “more rather than less likely.”
To better understand how the globalization process influences inequality, we thus need to move
beyond a comparison of nations to identify the development consequences of global
relations between “unequally powerful nations.” This we shall do by looking at how globalization
is managed.
3. HOW GLOBALIZATION IS MANAGED
After World War II, several institutions were created to manage the global economy and prevent a repeat of the Great Depression. These institutions include the IMF, the World Bank and the World Trade Organization. Conventional wisdom in political economy has held that these institutions’ role is to “level the global playing field.” They have not only persisted for over five decades but have also “expanded they membership, changed their mandates and changed their mission.” They have, however, become widely disputed. As Stiglitz notes, “International bureaucrats (..) are under attack everywhere… Virtually every major meeting of the IMF, the World Bank and the WTO is now the scene of conflict and turmoil.” Some scholars agree and argue that economic power influences global rules and their implementation, with winners usually making and implementing the rules to their advantage. Global institutions reflect the influence and power of Western advanced economies they claim, and the policy advice they give (or impose via conditionality) has been unhelpful if not detrimental since if often fails to consider the situation of the developing countries.
The evidence for this is mixed. The WTO points out that “trade is likely to expand and be more profitable under conditions of certainty and security as to the terms of market access and the rules of trade—pre-commitment around a set of rules also diminishes the role of power and size in determining outcomes.” Global institutions help protect that motivation when it is most important, for example in trade where countries with large markets, and hence market power, can obtain more favorable terms in bilateral negotiations with smaller countries. Global institutions constrain the powerful actors and ensure that trade is engaged in fair terms, reducing inequality by safeguarding rising incomes for all involved.
Nevertheless, critics maintain that developing countries have not gained much from trade agreements as most of the gains have gone to developed countries. This aspect of globalization is skewered in favor of rich countries they allege. As Stiglitz argues, “countries who have had globalization managed for them” by institutions like the IMF, have “by and large not done so well.” The key to successful globalization, he writes in “Globalism’s Discontents”, is that a country determines its “own pace of change” and makes sure that as it grows “the benefits (are) equitably shared.” The countries that benefited the most from globalization are those that rejected the basic tenets of the Washington Consensus Stiglitz maintains. The Washington Consensus argued for minimalist role for government, rapid privatization and liberalization of financial markets. Critics of the Consensus argue that there is little, if any economic evidence or theory that supports this, the consequences have been negative for most countries, and the main beneficiaries have been private investors in the developed economies. For instance, Stiglitz condemns the IMF for pushing developing countries to open their capital markets, arguing that such policies have had the most adverse effects as it has left countries vulnerable to huge speculative flows of money. As Stiglitz writes, “the [main] problem is that the IMF presents as received doctrines propositions and policy recommendations for which there is not widespread agreement; indeed, in the case of capital market liberalization, there was scant evidence in support and a massive amount of evidence against.” Developing countries have become prey to “hot money” and therefore vulnerable to inflationary bubbles, particularly in the real estate sector. When investor sentiment changes, the flow reverses “as suddenly as it appeared” leaving “economic devastation” in its wake.
Even the advice to open their economies to trade has not been unquestioned. The literature on the subject shows that the impact of trade openness on economic growth can be positive but also insignificant. In “Globalization for whom?”, Dani Rodrik stipulates that many countries that have opened themselves to trade and capital flows have been rewarded with financial crises and disappointing performances. Countries are often caught between IMF, World Bank and WTO agreements and the need to maintain confidence with international markets. Developing countries are deprived of the “room to grow” by the rules of the game. Economic development often requires unconventional strategies that do not fit the “ideology” of free trade and free capital flows. South Korea and Taiwan made extensive use of quotas, local-content requirements and export subsidies, all prohibited by the World Trade Organization today. The rules are often impractical and divert “attention and resources” from more “urgent development priorities.” Countries that have had the most impressive growth have developed their own rules to take advantage of world markets Rodrik resolves. “Developing countries are being asked to implement institutional reforms that took advanced economies generations to accomplish”, underscoring the “hypocrisy” of globalizers’ agenda. Particularly illustrative, is the example of the United States who, while a powerful advocate of the Washington Consensus, was not a paragon of free-trade while catching up with and surpassing Britain in the middle of the 20th century.
In sum, the management of globalization appears to be falling short of the goals defined in the mandates of institutions such as the IMF and the reasons seem numerous. Rich nations are the source of much needed export markets, foreign investment, technology and financial capital which translates into economic clout in negotiations to shape global governance. “This creates an in-built tendency for the rules of the game to be in the interests of powerful players” and thus globalization is more likely than not to increase inequality between rich and poor nations.
On the other hand, many scholars have argued that developing countries benefit from the institutional structure of globalization. States rationally decide to join the global institutions “managing” globalization so the net benefits must be positive (or less negative) than choosing to opt out.
However, the state of our knowledge is limited to the link between globalization and inequality at a global scale by having looked at aggregate economic indicators such as GDP. These measures are limited because they “implicitly assume that the intra-country distribution of income are perfect.” As Firebaugh observes, scale differences in inequality patterns and the “spatial impact of specific aspects of globalization” are important. He argues that we are currently witnessing a “historical shift in patterns of inequality”, a phenomenon that he has dubbed the “inequality transition.” This inequality transition is the fact that inequality has increased more rapidly within countries than between them since the 1980s. Examining this phenomenon should help shed some new light on the relationship between globalization and inequality at a subnational level.
4. THE “RIGHT” SKILLS
The debate on the distributional effects of globalization is often polarized between two points of view. One school of thought argues that globalization leads to “the rising tide of income” which raises all boats. “All income groups, even low-income groups, come out as winners in absolute terms.” The opposing school argues that even though globalization has increased overall incomes, the benefits are not equally shared across citizens with clear winners and losers.
Globalization has extended the depth and scope of markets: markets are bigger and the potential profits deeper. However, critics argue that the rewards have been going to those who have productive assets – namely financial assets, land and most crucial in a technology-driven world, human capital.
The returns to education have been rising steadily for several decades. This is true even though more and more people have been getting education. To illustrate, in the US, where the impact of global integration and the “accompanying information and communications revolution are most widespread,” the most highly-educated have enjoyed “healthy earnings” while the high-school educated have “suffered absolute wage losses”.
Many theories seek to explain this phenomenon; one, proposed by Nobel-laureate Eric Maskin of Harvard University is founded on what he calls “matching.” The central idea is that unskilled workers can become more productive if they work with skilled workers. Workers are divided into four categories: (A) skilled workers in developed economies; (B) unskilled workers in developed countries; (C) skilled workers in emerging countries; and (D) unskilled workers in emerging countries. Maskin argues that before globalization kick-started in 1980s, unskilled workers in emerging economies (Ds) did well because they could work with skilled workers in emerging economies (Cs). The skilled workers (Cs) experienced weak wage growth because limited communication and transportations links made it difficult for them to work with skilled workers in developed countries. The Ds however, by working with Cs became more productive and boosted total output. Thus, they could command a higher wage, narrowing the wage gap with skilled workers. Globalization has “jumbled the pairings” Maskin argues: Cs can now work more closely with As and Bs. Closer interactions with As and Bs has meant that Cs end up being more productive and earning more as a result. Unable to participate, the Ds are “left on the wayside” and their wages fall. As Cs pull ahead, the income gap widens again causing inequality to rise within developing countries. Maskin thus resolves that globalization has increased the demand for skilled workers and marginalized low-skilled workers in poor countries. The increasing integration of markets, capital flow and global technologies has pushed the demand for skills higher than the supply. Therefore, skilled workers in emerging countries (the Cs) are encouraged to look beyond their borders for places where they will be better able to deploy their skills. They are hence more likely to leave the poorest countries for the richer ones. For instance, Indian engineers can quadruple their earnings by moving from Kerala to Silicon Valley. While in the short term this brain-drain is a good thing for the individuals involved, in the long-run it could slow down convergence between rich and poor nations even further.
The marginalization of unskilled workers is not specific to emerging countries. Technology has boosted productivity and resulted in a shift from labor-intensive to capital intensive production methods. The new technologies have allowed the replacement of less qualified labor-intensive tasks with physical capital. The winners of this structural shift – driven by globalization – are capital owners and the highly-qualified labor force. The less-skilled workers (the Bs in Maskin’s matching theory) have lost out and inequality has thus increased. Data from the OECD shows the problem: “the average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD, up from seven times 25 years ago”.
Conclusion
Certain groups of people across all the income-spectrum of nations are more vulnerable than others. The forces of globalization pose challenges to countries: the worldwide elimination of trade barriers has meant that having the right set of skills is the difference between winners and losers of globalization. The dynamics of globalization require a “flexible, mobile force” to respond to structural shifts engendered by a global economy and those without the right skill set, whether in developed or emerging countries, have been put aside, increasing inequality within countries.
Globalization does not say that everyone will win from globalization, but that the net gains will be positive. The problem however, is that economic globalization has outpaced the “globalization of politics and mindsets.” Economies have become more interdependent but the institutional frameworks for ensuring that globalization is equitably shared between all citizens of the world are lacking. Some scholars argue that rising wage gaps should not be too alarming as they may be the “short-term price for higher long-run sustainable growth” as they provide the right incentives to acquire more education. Nevertheless, I refute my initial thesis: globalization has by and large increased inequality with clear losers and winners.