October 14, 2007
Globalization and Inequality-Becker
A report to be issued this coming week by the IMF (the technical analysis was released early) shows that greater globalization during the past two decades contributed significantly to rising inequality during this period in most developing as well as developed countries. The media greeted this conclusion about the connection between inequality and globalization with claims that the new report is "handing critics of globalization a powerful weapon" and "The report is an unusual admission by the IMF of the downsides of globalization" (Wall Street Journal, October 10, p.9). Yet a careful evaluation of the report's findings on income and inequality provides in most respects an optimistic assessment of the effects of globalization on developing nations.
The report analyzes what happened to incomes and inequality in over 50 countries. It finds that essentially all these countries had large increases in per capita incomes since the early 1980's. While the growth was positive at different income levels, including those at the very bottom, income growth was not uniform among different skills, or at different parts of the income distribution. Incomes grew faster for the more skilled and in higher income quintiles, which implies that various measures of inequality typically increased in developing nations.
To explain these results, the IMF authors divide the effects of greater globalization into expanded world trade, greater foreign investment, and increased transfers of modern technologies. They find that all three dimensions of globalization tended to increase per capita incomes of both developing as well as developed countries. International trade theory implies that trade by a poorer country would increase the relative earnings of its lower skilled workers because richer countries want products from poorer countries that use relatively large quantities of unskilled workers, such as textiles. The report's evidence quite strongly supports this building block of trade theory: greater trade alone would have lowered earnings inequality within developing countries.
However, the most powerful effect on inequality from globalization is due to transfers of modern technologies. The evidence from developed economies has been that modern technologies, like the computer and Internet, favor more educated and other skilled workers; in economic parlance, that these technologies are skill biased. This effect of technological progress has been used to explain the sharply rising gap in earnings between college graduates and others during the past three decades in the United States (see my discussion of inequality in the blog entries for April 23 and December 10, 2006). Not surprisingly, the IMF's study finds that a similar skill bias applies to international technology transfers, that they raised the earnings gap between more skilled and less skilled workers in developing countries. In other words, foreign direct investment has a skill bias too, so that its sharp growth over the past 25 years raised inequality in developing countries. Better capital markets had a similar effect on inequality. However, the evidence in this report indicates that the effects on inequality due to foreign investment and capital market liberalization, while not minor, were much smaller than the effects of technology transfers.
Is this greater gap between the earnings of more and less skilled workers a good or bad result of globalization? Let us accept that greater inequality is not good, other things the same, but other things are different in the IMF results on inequality. The increased earnings gap between persons with more and less education in developing countries reflects that the earnings of more educated individuals rose faster than the earnings of the less educated. The IMF report clearly shows that generally the poorer and less educated in developing nations also became better off in that they have more to spend on food, shelter, health, automobiles, and the other goods that they desire. This improvement in wellbeing at the lower end of the income distribution surely should count as a benefit of globalization.
The larger earnings gap by education essentially means that the returns on investments in schooling increased. Few critics of globalization would claim that its effects were bad if globalization significantly raised the returns to financial or physical capital owned by local investors in developing countries. So how can one complain that globalization is bad because it raises the returns on the education of local human capital investors? Higher returns to human capital investments as well as greater returns to plant and equipment mean that the economy is more productive, which should be a welcome development to poorer as well as richer countries.
Yet intellectuals and politicians in many countries of Latin America, Africa, and even parts of Asia have heavily criticized globalization and its effects. I believe that developing countries in which the criticisms are strongest are generally countries that have done a bad job of educating its population. Higher returns on investments in education and other human capital are small comfort to the children of poor families who often do not have easy access to secondary schools, let alone to universities and other forms of advanced investments in human capital. The lesson of the IMF report and other studies is that globalization is not the source of these serious problems. Rather, the lesson is that many developing countries have to do much more to open up access to better and greater education for children coming from lower income families. Only then would these families be able to take advantage of the higher returns to education produced by greater trade and the inflow into their economies of modern technologies and foreign capital.
Posted by becker at 07:44 PM | Comments (35) | TrackBack (0)
Globalization and Inequality--Posner's Comment
Becker has accurately summarized the International Monetary Fund's recent report on the effect of globalization (meaning increased integration of the world's economy) on inequality. (It is chapter 4 of the IMF's "World Economic Outlook" published this month and available online at http://www.imf.org/external/pubs/ft/weo/2007/02/pdf/c4.pdf.) In essence, the report, while acknowledging serious data limitations, finds that average incomes have increased significantly in most nations in recent decades, but that income inequality has also increased in most nations, mainly because of disproportionate increases in the incomes of the top fifth of the populations. The incomes of the other quintiles have increased too, but not as fast, so that overall the gap between rich and poor has increased although the poor are better off--just not as better off. Both the increase in average incomes, and especially the increase in inequality, are driven mainly, the report finds, by increased utilization of advanced technology, which increases the returns to high-skilled workers relative to the returns to low-skilled or unskilled ones. The report suggests that greater investment in education would tend to reduce inequality by increasing the proportion of high-skilled workers.
I want to question three assumptions of the IMF report. The first is that increased income inequality is a bad thing, the second is that an increase in world average incomes is a good thing, and the third is that greater investments in education are bound to reduce inequality.
I do not think that increased income inequality is bad (regrettable, unfortunate, deplorable, etc.), in general (an important qualification, relaxed below), when it does not involve any reduction in the incomes of a substantial fraction of the population. Suppose that over some period the average income of people in the bottom four quintiles of a nation's income distribution increases by 2 percent and the average income of people in the top quintile increases by 10 percent. The result is increased income inequality, but so what? Everyone is better off, and why should the fact that the rich are better off by a larger percentage concern anyone? What is true is that if the baseline is extreme inequality and many people are below the poverty level, a further increase in inequality can be politically destabilizing. Suppose 99 percent of a nation's people live in poverty and the other 1 percent are rich and over some period the average income of the 99 percent rises barely at all, lifting few above the poverty level, while the average income of the 1 percent who are already rich doubles. Such a pattern would exacerbate what would doubtless already be a high degree of social unrest. I argued in my blog post of December 10, 2006, that the continuing enrichment of the already superrich stratum of the American population is a potential source of political problems too. But concern with the impact of particular forms and degrees of inequality in particular countries at particular junctures in their history does not justify concern with a rise in inequality in the world as a whole, an approach that while natural for the IMF to take treats the entire world as if it were a single nation, thus abstracting from particular circumstances of particular nations, though it is the particulars that determine whether inequality is a serious problem.
It might be argued that, given diminishing marginal utility of income, average and total human happiness would be increased if the incomes of the poor grew more rapidly than those of the rich, because presumably an extra dollar confers less utility on a rich person than on a poor one. But this observation would be pertinent only if rising inequality were a product of unsound policies, whereas the IMF report attributes it to economic factors, such as technological progress and absence of barriers to foreign investment, that are vital to continued growth in average incomes. The poor, unless consumed by envy, are not made better off by policies that leave them as poor (or make them even poorer) but reduce the incomes of the rich.
Concern with inequality, it should be noted, is distinct from concern with poverty. It would be possible to alleviate poverty without reducing the share of income going to the wealthiest quintile of the population. Focusing on quintiles tends to break the link between equality and welfare. Suppose some adjustment in the tax code resulted in reducing the average income of persons earning $100,000 a year by 2 percent and increasing the average income of persons earning $50,000 a year by 1 percent (the difference reflecting the much larger number of persons in the lower income bracket and the deadweight cost of the tax increase on the higher-income taxpayers); would that increase average happiness? I doubt it.
My second proposition is that, while again it is natural for an international organization like the IMF to consider increased global wealth a very good thing, there is no reason for any given individual to think that. None of us is a citizen of the world. We are citizens of particular countries, and our personal welfare is bound up with the welfare of our country rather than with that of the world as a whole. Do Americans benefit from the rapidly increasing wealth of China? Some do, of course, both as consumers and as suppliers. But there many losers (besides the obvious ones--those who make products that compete with imports to the United States from China), since China's rapid growth has increased the price of commodities such as oil, severely aggravated the problem of global warming, and contributed to the rapid growth of Chinese military power, which is a potential danger to the United States. Russia's increasing wealth has made Russia more bellicose and less friendly to the United States; and, in general, nations such as Russia that are rich in natural resources, especially oil, are not dependable allies of the United States--and they are all growing richer. And the technological progress that is such a big factor in increased world wealth makes international terrorism more dangerous than it would otherwise be. Where would terrorists be without cellphones, the internet and web, and cheap international air fares?
Third, it is not certain that increased investments in education would result in less inequality. There is the cost of such investments to consider, and who within a society would bear that cost. (Taxpayer-subsidized tuition for students at Berkeley does not increase income equality in the United States.) One must also consider who would benefit the most from education. Suppose everyone in a nation had the identical opportunity to obtain as much education as he or she could benefit from. The abler students would receive a better education than the less able, and the preexisting inequality of human capital might persist or even increase. For notice that in the United States income inequality has been growing even though educational opportunities are abundant, with more than a third of the population obtaining some college education; most of the rest could obtain it as well if they thought they would benefit from it. Presumably, then, the countries that ought to be considering greater investment in education for the sake of reducing income inequality are those in which that inequality is greater than it is in the United States. In countries in which it is less, a greater investment in education would increase average incomes but might leave inequality unchanged--or even increase it to the U.S. level.
Posted by Richard Posner at 07:27 PM | Comments (37) | TrackBack (0)
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