Friday, March 07, 2008

Has Globalization Deepened Inequality?

Dieter Braeuninger, Deutsche Bank Research
YaleGlobal, 6 February 2008

The rise of the global economy has been accompanied by large increases in international trade, investment, technological innovation and migration. These changes cannot be undone, and they have created new opportunities for economic growth in industrialized countries. But the global labor force has expanded fourfold since the 1980s, and supply of unskilled labor exceeds demand. To extend promise to more citizens, argues economist Dieter Braeuninger, developed nations should institute new forms of social assistance, with particular emphasis on education, employment assistance and health care. As industrialized countries benefit from globalization, they have a responsibility to minimize conflict, ensure that all citizens have the chance to gain useful and diverse skills, and distribute benefits more evenly. – YaleGlobal

FRANKFURT: Skepticism has been growing in Europe and the US over globalization. Besides globalization opponents, established economists and politicians question whether undisputed benefits of the global division of labor come at increasingly heavy costs, especially social injustice. However, a closer look shows that a growing economic gap in developed countries has more to do with evolving technology than with global connectedness.

Several months ago US Federal Reserve Chairman Ben Bernanke cautioned about widening inequality in the US, and German Federal President Horst Koehler refers to social injustice in Germany. Both the Fed chairman as well as the German president pledge sensible political reactions, especially greater effort in education.

It is not possible to reverse the global division of labor that globalization has brought. As Bernanke, Koehler and many other economists warn, neither is protectionism a solution. Insulation against the global market would be a burden to manufacturing companies dependent on components and other inputs from emerging markets. Consumers would be forced to pay higher prices for imported goods, leading to a decrease in domestic demand. The result of protectionism would hence be a loss of economic prosperity, which would disadvantage the less mobile employees even more.

The solution to the economic gap has to be found in forward-looking strategy combining new educational policy, health care and benefits.

Table 1. Adjusted wage shares - ongoing downward trend? Enlarge image

The challenges are clear. Income inequality has risen in the industrialized world with skilled workers’ incomes rising faster than compensation for low-skilled labor. An international comparison that economists use to determine economic inequality, Gini coefficients, shows the problem. The average Gini coefficient for private households’ net income for the Organization for Economic Cooperation and Development countries climbed from 0.29 in 1985 to 0.31 in 2000. This means income inequality has gone up by 6 percent, as the Gini coefficient 0 stands for perfect equality and 1 for absolute inequality where one person has all the income and everyone else has nothing. Recent data for the European economies suggest the trend continues. Above-average inequality can be found in the UK, Italy, Spain and especially the US, with 0.37, while income is less concentrated in Germany with 0.29 and especially the Nordic countries.

It would be inaccurate simply to conclude that wages of high-income earners have increased faster than those of low-income earners. A major source of income inequality actually is unemployment. In many countries, there exists a strong correlation between the increase in unemployment, which mainly affects the low-skilled, and income inequality. While unemployment often follow business cycles, the long-lasting distributional trends nevertheless point to other more structural causes of growing wage differentials. The media often blame globalization as the major driving force. Economists, however, believe that globalization takes a backseat.

Instead, they identify the strong pace in technological progress and, in particular, the revolution in IT as the engine of change. The triumphant advance of the microchip, the PC and the internet kick-started a wave of automation, as well as a transition to flexible and accelerated production processes. This not only boosted productivity, but also resulted in a shift from labor-intensive to capital-intensive production methods.

The winners are hence both owners of capital goods as well as the highly qualified labor force. Investments into modern IT-dependant production facilities need extensive capital funds. The installation and utilization of these facilities require qualified specialists. In addition, the new technologies allow the replacement of less qualified labor through physical capital, such as machines and computers.

Globalization and geographic dispersal of the labor force accentuate these changes. The global labor force has risen fourfold since the beginning of the 1980s. The supply of basic labor has increased enormously. The globalization of labor affects the industrial countries in three ways: It leads to a strong expansion in trade, more extensive direct investment and manifold migration.

World trade has grown by an average of 7.1 percent yearly since 1980 and therefore has almost sextupled in less than a generation. Emerging markets and developing countries increased their share of global exports by 25 percent to 37 percent. Even greater than the rise in trade has been the increase in foreign direct investment – a value of US$916 billion in 2005 compared to $55 billion in 1980.

According to economic theory and experience so far, trade leads to specialization and differentiation of production as well as more intensive competition, thereby increasing prosperity. The worldwide elimination of trade barriers has opened new and promising markets for companies based in the industrial countries. By off-shoring production, firms optimize their production processes beyond national borders. Companies exploit economies of scale in the long run. But the greatest gainers from globalization are the consumers. They benefit from a more diverse supply of goods and services at lower prices.

Despite the many benefits, increasing specialization poses challenges to the industrial countries. In particular companies and workers producing labor-intensive products face strong pressure from competition. Change has always accompanied trade. However, evidence points to an unprecedented pressure to adapt today, given the dynamics in the three dimensions of globalization and in the technical progress. Responding to this structural change requires a flexible, mobile labor force. Mobility of the less skilled is crucial in this context. As long as less-skilled workers cannot shift to more productive tasks, increasing income inequality remains a threat.

The goal is evident. As many citizens as possible should participate in the gains of globalization. In view of the promising yield so far from investments in international capital markets, it would be possible to reduce income inequality within the labor force by increasing personal capital formation, especially by broader shares ownership. In Germany, only 7 percent of households own shares compared to more than 25 percent of households in the US. This reflects a more risk-averse attitude among the population in Germany, but also the impact of the expanded state-pension and public-health insurance schemes. Enhanced private capital formation in Germany and other European countries is all the more important as the public schemes can no longer provide a sufficient level of benefits given the imminent aging population.

There’s a need to strengthen education and further training. The correlation between individual qualifications and personal income is high. Most importantly, education and training act as an effective shield against unemployment. In general, it should not be accepted that in countries such as Germany, Italy and the US, basic skills – for instance in reading and or math – are no more than on par with or, indeed, below the OECD average. Education and basic vocational training need to be enhanced over any individual’s lifetime.

For the less skilled workers, employability is a key concept. Training should include individual-related measures to improve personal skills and social competence as well as other assistance in removing impediments, through mobility, i.e. transportation, aid or childcare. Income support, in the form of a negative income tax, should accompany such policies.

A dynamic economy finds it easier to achieve equitable participation in the benefits generated by globalization. Hence, much depends on sound economic policy that strengthens the growth forces and uses prosperity generated by globalization to provide a basic safety net, with health and retirement benefits. All in all, much can be done to increase the number of globalization winners in the industrial countries.

Dieter Braeuninger works as senior economist at Deutsche Bank Research, the Deutsche Bank Group's think tank in Frankfurt, Germany. This article is based on a study by Dieter Braeuninger: “Globalisation and Distribution – Industrial Countries Also Face the Challenge,” Deutsche Bank Research, Current Issues, November 2007.

Rights: © 2008 Yale Center for the Study of Globalization

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