Globalization and Inequality COMFAMA Program Globalization and Inequality September 2011 Arvid Lukauskas Columbia University Today: How is globalization affecting the prospects for growth of emerging market countries and what is the role of the state and public policy in promoting growth?

Globalization Increased integration of national economies so that economic activity is less affected by national borders Manifested in more open economies characterized by: higher levels of trade greater capital mobility increased levels of migration

World GDP per Capita, 1950-2005

GDP Growth, by Income Group Growth has been very high in this era of globalization, with all income groups and regions taking part 4

Within Country Distribution of Income, by Country

The Ten Countries with the Highest Gini Coefficient

Determinants of Inequality Level of development (income) Demand for factors of production Technological progress Effects of integration Political, social, and economic institutions Economic geography Government policy, especially extent of redistribution

Distributional Concerns Increased growth in the era of globalization has not necessarily meant that the benefits have been shared equally How has globalization affected the distribution of income across countries? How has it shaped the distribution of income within countries? How has it affected the level of poverty?

Distribution of Income on a Global Level Increase Inequality Globalization increases inequality across nations because countries grow at vastly different rates In particular, it widens the gap between the rich and poor Open markets favor more productive firms from developed countries Forcing developing countries to open their markets exposes them to unfair competition and results in the exploitation of the poor by the rich Decrease Inequality As economic integration increases, income across countries should converge First, factor prices, then productivity levels, then income converges Economic theory says that small developing countries benefit more from international trade and capital flows than large developed countries

Distribution of Income Within Countries Increase Inequality Economic forces benefit some social groups much more than others, creating “haves” and “have-nots” The “exit threat” of mobile asset holders augments their political power at the expense of labor The capacity of state officials to redistribute income across social groups diminishes No Direct Effect It is impossible to determine a priori what the impact of globalization will be on inequality within countries: Globalization leads to higher levels of trade and growth, but there is no systematic relationship between these variables and the degree of income inequality Depends of relative abundance of factors of production The ultimate impact will depend on a variety of factors, including the national distribution of infrastructure and equality of access to education and other public goods

Stopler-Samuelson Theorem Advanced Industrial Countries Tend to have a comparative advantage in capital, skilled-labor, and knowledge intensive goods Increased trade will benefit those factors at the expense of low-skilled labor and increase income inequality Emerging Markets Tend to have a comparative advantage in labor intensive goods – especially low-skilled labor intensive goods in many countries Increased trade should benefit labor and decrease income inequality

The Level of Poverty Increase Poverty Decrease Poverty Globalization will increase poverty by contributing to a greater increase in income inequality within countries than can be offset by any trickle down from faster growth (if any) The poor are least prepared to succeed in an integrated global economy, so they will fall further behind Decrease Poverty Globalization will decrease the level of poverty by increasing growth within developing countries Higher growth will result from more trade and increases in overall productivity Higher levels of growth = higher income per capita for all income segments, including the poor It is possible, but unlikely, that increases in income inequality could be great enough to negate the positive effects of higher growth on poor incomes

Empirical Evidence There is a strong consensus on the impact of globalization on levels of poverty There is little consensus on the effect of globalization on income equality across and within countries

Trends in Global Inequality of Individual Incomes Source: Bourguignon and Morrison (2002) as found in Lindert and Williamson (2003)

Divergence, Big Time: 1820-1992 Source: Pritchett (1997) To start the discussion of inequality, look at a basic stylized fact about growth divergence since 1820 The ratio of richest to poorest countries went from 6 to 1 in 1820 to 70 to 1 in 1992. Before the Industrial Revolution 1700-50, the ratio was about 2 to 1. The growth rate of developed countries shows convergence (their growth rates are bunched in a narrow group), but the growth rates between developed and developing countries show considerable divergence and there is divergence among developing countries: Of 108 developing countries, 11 grew faster than 4.2% in 1960-1990. 16 countries had negative growth (Mozambique -2.2%); 28 had growth rates of less than 0.5% and 40 had growth rates of less than 1.0% Divergence continued over the period from 1960-1990, but what has happened since? Source: Pritchett (1997)

The “Convergence Club” Source: Dowrick and DeLong (2003)

Globalization, Growth and Poverty: Building an Inclusive World Economy World Bank study published in 2002 Comprehensive effort to measure the effects of globalization on the distribution of wealth and poverty The study divides developing countries into two main groups: Developing countries that have become more integrated into the global economy Developing countries that have not done so I would like to report the findings of one of the most comprehensive and widely reported studies published by the World Bank. Does not make a clear distinction between those that wanted to integrate and couldn’t and those that chose not to.

Globalizing Developing Countries * The 24 developing countries that increased their integration into the world economy from 1980-2000 have seen: significantly higher growth slightly less inequality within countries lower levels of absolute poverty longer life expectancy and better schooling These countries included China, India, Hungary and Mexico and were home to some 3 billion people. The sample is skewed toward Asia, which make up 85% of the group of globalizers.

Less Globalized Developing Countries The 49 developing countries that have not integrated into the global economy have struggled. These countries are found primarily in Sub-Saharan Africa, the Middle East and the former Soviet Union As a group, these countries actually grew at a negative rate (about –1.0%) in the 1990s. The number of people in absolute poverty rose by 4% to 437 million in the 1990s. Life expectancy and school enrollments declined in many countries.

Trends in Inequality Among Countries Globalized developing countries have gained ground on both developed and less globalized developing countries

Different Measures of Inequality Gini coefficient: how far does income distribution diverge from a perfectly equal distribution? Higher score indicates higher divergence. Unweighted: each country’s GDP per capita is treated as one observation, regardless of size Weighted: Each country’s GDP is weighted by its population, so more populous countries count more

Robert Wade on Inequality Inequality using market rather than PPP exchange rates shows much greater inequality World PPP-income inequality using equal country weights has increased substantially World PPP-income polarization has increased dramatically World PPP-income inequality has been decreasing, but the result is largely due to China and India

Patterns of Inequality Need to be careful in interpreting this graph This measures income inequality looking at all households in the world, by properly weighting each country by its population size. Income inequality within China has increased, but the inclusion of Chinese households means that world income inequality declines because the large number of Chinese have caught up with the rest of the world. Income inequality has also increased greatly in the US In sum, the decline in across-country individual inequality, correctly waited by population, more than offsets the population-weighted average increase in within-country individual inequality. Sala –I-Martin (2006)

Wages Catching Up in Emerging Markets (Percent of US manufacturing wages) Source: IMF

Trends in Poverty Absolute levels of poverty have declined in historical terms From 1981 to 2001, the percentage of the world’s population living in poverty has declined from 40 to 21%

Poverty Rates Sala –I-Martin (2006)

Overall Trends: Poverty

What is the Relationship between Growth and Poverty Reduction? Faster growth can lead to poverty reduction The pace of poverty reduction in different regions was closely associated with their growth rate

Source: OECD 2008

Changes in Within Country Inequality

What is the Relationship between Growth and Inequality? There is no systematic association between growth and inequality The fear that growth in poor countries is accompanied by higher inequality is not generally true

What is the Relationship between Trade and Inequality? There is no simple association between trade and levels of inequality More trade openness tends to raise the income of the poor as much as overall per capita income

US Household Income Inequality

Trends in US Income

Levy and Temin 2007

The Income of US Workers Has Stagnated Between 1980 and 2005, non-farm business productivity increased by 67.4%. Yet: Median weekly earnings have increased only 14% (from $613 to $705) Median weekly compensation (earnings plus benefits) increased just 19% (from $736 to $876) College-educated women were the only group who saw their median compensation grow in line with productivity

Demand for Labor Skill-biased technical change has lowered demand for low-skill (or mid-skill) workers and increased that for high-skill, better-educated workers Households demand more skill- and knowledge-intensive goods as national income increases The data generally show a widening income gap between skilled and unskilled workers But the income of most types of unskilled and skilled workers is not increasing in line with productivity Some new jobs, notably, in finance, have a winner-take-all character and people holding them have enjoyed huge increases in income

Effects of Globalization Globalization – notably, trade and outsourcing – has the potential to hurt labor in advanced industrial countries because competing against lower-wage workers in developing countries puts downward pressure on developed country wages Trade and outsourcing probably have a relatively small impact on wage levels. Take the US case: Trade only accounts for about 12-15% of US economy Trade with low-wage countries is a very small percentage of US trade Estimates are that only 25% of variance in US wages is due to effects of globalization Developed country workers can compete with low-wage workers in emerging markets if the wage differential is less than productivity differential

Political Institutions US created an institutional structure during the New Deal and immediate post-war period (the “Golden Age”) that distributed gains broadly: Labor unions were accepted “Treaty of Detroit”: unions agree to minimal labor disruptions and management control over production decisions in exchange for compensation adjusted for cost-of-living and productivity gains; government helps broker the deal High top-bracket income tax rate Meaningful minimum wage Resulted in rapidly rising wages that led to an expanding middle class and mass upward mobility

Providing a Social Safety Net Traditionally, governments have provided social insurance, such as unemployment compensation and worker training, to those hurt by economic change, such as that brought about by external forces like globalization Today, there is growing concern: Is globalization and economic fragility restricting governments’ ability to increase spending on social programs at a time when it is badly needed? Certainly, one of the principle tasks facing government moving forward is to find creative new ways to provide a social safety net at low cost

Pro-Poor Growth in Emerging Markets No improvements for the poor are possible if growth is not high and sustained The key element: Connect the poor to markets and social services Expand physical infrastructure and provide more equal access Improve social services and make them more equitable Reduce transaction costs Enhance governance structures to improve voice and accountability

Develop Agriculture Improve rural infrastructure Roads, irrigation, power supply, communications systems, and social services, especially education and health Allow agricultural prices to rise, increasing farmer incomes Does this still make sense today, when agricultural prices are skyrocketing? Effects on urban poor? Make every effort to target smallholders as well as large agri-businesses Many countries are characterized by dualism in the agricultural sector Some selective intervention to target smallholders is often warranted – reduce risk and improve access Strengthen property rights to land Develop agricultural processing industries

Urban Sector Focus on enhancing employment opportunities in both the formal and informal sectors: Embrace trade Improve the investment climate Remove labor market rigidities Improve educational opportunities, especially for women Improve infrastructure