World 3.0

by Pankaj Ghemawat

  Chapter Nine

  Global Exploitation

  Source: Khalil Bendib

  MOST ECONOMISTS FOCUS on the efficiency of market outcomes—how to deliver the most goods and services using the fewest resources. And in fact, previous chapters looked at a number of hot-button fears relating to the breakdown of market efficiency—concentration, externalities, risks, and imbalances. But efficiency isn't everything. Most people care about fairness or equity, and many think globalization is at best unfair and at worst blatantly exploitative. So we need to consider how the benefits and costs of cross-border integration are distributed across people instead of looking at just their aggregate impact.

  The cartoon that begins this chapter conveys two distinct distributional concerns. In rich countries, concerns abound that trade with poor countries threatens high wages, job security, and hence living standards. In developing countries, some people fear that globalization locks in positions of relative disadvantage, depriving countries and individuals of paths to prosperity that today's rich once traveled. Behind both arguments lies the notion that globalization has been imposed by the more powerful on the less powerful, and that in particular it benefits owners of capital over workers, since capital is mobile but labor mostly is not.

  This chapter will begin by reviewing these concerns and will then turn to look at the evidence. It will first summarize economic differences among people around the world and the countries in which they live. Then it will turn to globalization's impact on workers in advanced economies, addressing concerns about rising inequality and declining pay levels and job security. And finally, it will assess globalization's effects on workers in developing countries. We'll see that globalization is not inherently exploitative, but that some do lose out when markets get integrated. The chapter concludes with suggestions for shaping integration so as to create a fairer as well as more prosperous world.

  Inequality and Integration

  Economists have a tendency to avoid distributional issues in favor of a “value-free” emphasis on efficiency. When they do engage with value-laden distributional issues, though, they usually focus on income inequality, which will also be the tack taken here. But it is useful to begin by noting two critiques of this focus on equality/inequality.

  From the right, Milton Friedman has argued that a focus on equality inevitably ends up focused on the equality of outcomes instead of the equality of opportunities, to the detriment of the latter and at the expense of long-term economic growth.1 The distinction between equalization of outcomes and of opportunities is indeed important. But the trade-off that Friedman highlights is just a possibility that is particularly likely to apply if the equalization of outcomes is pushed too far. This is not an obvious characterization of a world in which 60 percent of the variation in individuals' positions in the global income distribution has been estimated to be accounted for by the countries they are born in and another 15–25 percent by parental (within-country) income class.2 Other measures attribute between 66 to 87 percent of income inequality among individuals around the world to differences in countries' mean incomes.3 While we lack comparably detailed data on the distribution of wealth, which is what gets transmitted between generations, circumstances—as in country of birth and parental position—seem to account for even more of the variation along that dimension!

  These data suggest that equality of opportunities as well as of outcomes lag in the real world. It is at least plausible that we are operating in a part of the policy space where equalization of opportunities and of outcomes might go hand-in-hand instead of being subject to a fundamental trade-off. And so we shouldn't simply assume that it would be futile—or worse—to work to reduce global inequality: the possibility merits attention.

  From the left, noted trade economist Jagdish Bhagwati has labeled measures of global inequality as irrelevant—since there is no global polity—and a distraction from the real problem of poverty.4 This is a forceful reminder that the conditions of the very poor are of particular concern—a point that will be followed up on in Part III as well as later in this chapter. It also hints at the difference between reducing inequality by lifting people out of poverty versus dragging down the rich: the former is clearly preferable. But that said, it still seems useful to start to take stock of where we are by looking at the rich, the poor, and everyone in between—although we might then want to focus our analysis on particular parts of the income distribution (the very poor) or particular subgroups (women, children … ) or particular geographies. The usefulness of taking stock is enhanced by people's tendency to underestimate the extent of global income inequality by large margins. To see this, try to get people you know to guess the levels of some of the measures of inequality presented in this chapter.

  Traditionally, economists have seen some inequality and risk of job losses as necessary but undesirable by-products of the incentives required to spur economic growth. They've seen redistribution as reducing growth by lowering incentives to get rich.5 Newer theories view inequality as itself hampering growth by creating political and social instability and discouraging the rich from accumulating wealth.6 The World Bank has affirmed that “policies to improve the distribution of income and assets can have the double benefits of increasing growth and increasing the share of growth that accrues to poor people.”7 Of course, high levels of inequality don't only hurt the poor. Inequality impedes happiness among the middle classes due to pressure to “keep up with the Joneses.” Some research even indicates that people will deny themselves material gains if they think accepting those gains would unfairly give even larger benefits to others. And Jeffrey Sachs also linked inequality to a number of the economic failures that lead to failed states.8

  What is of particular interest here is the relationship between globalization and inequality. The most famous theoretical result in the literature is the so-called factor price equalization theorem, now more than fifty years old, which states that in the absence of market imperfections, frictions, and restraints, trade will lead to an equalization of factor prices—including wage rates—across countries, even without any cross-border movement of labor and capital. This predicted reduction in inequality used to be promoted as another benefit of trade, and a big one. But with rising worries in countries such as the United States about wages there coming under pressure from low wages in countries such as China, there has been some rethinking or at least shift in emphasis.9

  Thus, in 2004, Nobel Prize winner Paul Samuelson, one of the developers of the factor price equalization theorem, published an article emphasizing that technical progress of a particular sort in a trading partner such as China could reduce welfare in the United States.10 Various critiques have since been offered: the mechanism proposed by Samuelson isn't new; the losses under his mechanism reflect reduced rather than increased trade; and the dynamics assumed by the mechanism don't fit with the empirical evidence.11 But to me, the salient point is that Samuelson, of all people, chose to emphasize what he did when he did—and that it aroused huge attention in the media where, despite his disavowals, it was mostly seen as an argument for protectionism.

  More broadly, the whole controversy seems to me to be an illustration of the muddle that comes from using thought experiments associated with moving to World 2.0 to guide behavior in World 3.0. To expose the problem, let me start with an even more basic model: an image, really. Visualize a tub filled with water, with a barrier in the middle. On one side, the water level is high; on the other, it's low. Remove the barrier, and they equalize. Likewise, in a borderless world, we would expect that wages would converge or jobs would move from the high side to the low side. If this model seems outrageously simplistic to you, that's good, but don't assume everyone agrees. This is basically the “giant sucking sound” Ross Perot predicted would send U.S. jobs to Mexico under NAFTA. Pat Buchanan, author of tirades such as “Suicide by Free Trade,” and Lou Dobbs might not be using much better models.

  In reality, labor markets don't much
resemble bathtubs. You don't just lift a barrier and go from World 1.0 to World 2.0, instantly overpowering all cultural, administrative, geographic, and economic differences. Even with complete integration along all other dimensions, we'll never see a single labor market shifting to a single new wage level. Labor is not a simple commodity; people have different skills, experiences, preferences, capabilities, and so on. Also, the informational problems described in chapter 7 abound in labor markets. Picture millions of little pools of labor with mazelike connections, some operating inefficiently, many internal to companies, most local or national, and only a few regional or global. Considering how borders actually work in semiglobalization, opening up is more like partially opening valves between pools than removing barriers wholesale.

  The simplistic bathtub model of job losses also leaves out gains from trade and all other sources of growth. And it fails to incorporate the fast-growing domestic demand for labor in emerging markets. In rich countries, it might seem like the whole massive populations of the developing world are clamoring to sell you cheap products and services, but in reality, even a country like China sees mostly domestic development. Yes, developing countries seek increased share in export markets based on cheap labor, but don't forget, cheap labor means relative poverty, which is precisely what those countries are racing to escape as fast as they can.

  Oversimplified models also overlook productivity differences. Wages have been shown repeatedly to track labor productivity very closely, a point to which I will return at the end of this chapter. As long as workers in developed countries are more productive, they'll still enjoy higher pay, and that's going to be the case as long as they use more capital equipment, have more education, enjoy better business environments, and so on.

  So, we need to cast aside images like a global pool of labor, along with more sophisticated treatments like factor price equalization, that don't account for the complexities of World 3.0. More realism leads to the conclusion that integration is sometimes a win-win deal for everyone, including workers, but that in other cases, some do gain at the expense of others. When there are both winners and losers, we have to try to provide some kind of protections for the latter—but this is rarely best achieved by imposing trade protectionism.

  And for those of us who would like to see more integration, it's also important to keep an eye on inequality because economic disparities can be a barrier to globalization. Data suggest that countries with higher inequality engage in less trade. Inequality also dampens public attitudes toward markets and protectionism. And such sentiments can have a real impact on policy. Jeffrey Williamson links rising inequality in the New World before World War I to a backlash against immigration (reminding us of the particular need to manage that cross-border flow) and trade that contributed to deglobalization during the interwar years.12 So while the Communist notion of enforced equality of outcomes is clearly a bad idea, distributional concerns cannot and should not be ignored. There are good reasons to try to provide more equality of opportunity, if not more equitable outcomes themselves. Let's start to explore them by looking at some real data on inequality—first globally and then within advanced and developing countries.

  Global Inequality

  The top tenth of the world's population got 57 percent of the world's income while the bottom 70 percent got only 5 percent in 2002.13 But it is useful to look more systematically at the shape of income distributions rather than simply focusing on one or two data points, and to put present levels of inequality into historical perspective. There is no single (“value-free”) way of summarizing an income distribution into a number, but the most widely used measure of inequality is the Gini index (see “The Gini Index of Inequality”).

  Before agriculture, in the early days of World 0.0, virtually no inequality existed, i.e., the Gini index was close to zero. Everyone was poor. What inequality there was reflected differences in the natural bounty of different locations. Keep this distinction in mind—some inequality results from differences in prosperity across places (“location inequality”), which is different from inequality caused by local or national social stratification (“class inequality”).

  If we fast forward to World 1.0, we find that the Gini index measuring inequality among individuals around the world was 43 in 1820 according to an estimate by Branko Milanovic,14 about the same as the U.S. Gini in the early 1990s.15 Furthermore, class inequality (inequality based on one's position within a country's income distribution) explained 65 percent of global inequality, with only 35 percent reflecting differences in average incomes across countries.16 Differences in relative prosperity were more muted than today, and more of the differences occurred within rather than between countries.

  The Gini Index of Inequality

  The Gini index is probably the single most widely used measure of income inequality. It is best visualized in relation to the Lorenz curve, which plots the proportion of the total income of the population (y axis) that is cumulatively earned by the bottom x percent of the population (see diagram). The line at 45 degrees represents perfect equality of incomes. The Gini index can then be thought of as the ratio of the area that lies between the line of equality and the Lorenz curve (marked “A” in the diagram) over the total area under the line of equality (marked “A” and “B” in the diagram); i.e., G = A/(A + B).

  The Gini index can range from 0 to 1 but is usually multiplied by 100 to yield a percentage between 0 and 100. A low Gini index indicates a more equal distribution, with 0 corresponding to complete equality, while higher Gini indices indicate more unequal distribution, with 1 corresponding to complete inequality.

  Milanovic's analysis indicates that inequality soared during the rapid economic expansion that took place in World 1.0. By 1950, the Gini index for individuals around the world had risen to 64, and location inequality had overtaken class inequality. Differences in average incomes across countries accounted for 86 percent of the inequality among people around the world.17 What happened? Actually, nothing you don't already know. Some countries got rich before others. World 1.0 borders were really strong, making for some large differences in economic circumstances. A small number of rich countries rose up, and everywhere else, pretty much everyone stayed poor, as shown in figure 9-1.

  As far as globalization goes, the period after 1950 holds the most interest. Given the concern about exploitation, it's surprising that all of three of Milanovic's inequality measures shown on figure 9-1 registered almost all of their growth before 1950, whereas exports as a proportion of GDP (i.e., globalization) really took off after 1960. The proportion of inequality among individuals explained by cross-country differences in average income (location inequality) also basically stopped rising after 1950.

  New analysis by Maxim Pinkovskiy and Xavier Sala-i-Martin, based on a different methodology than Milanovic's, is even more encouraging. They estimate that the global Gini declined from 68 to 61 from the early 1970s to 2006, largely due to tremendous growth in East Asia, as shown in figure 9-2. Present institutional arrangements certainly haven't prevented the emergence of (some) formerly poor countries.

  So recent trends give us strong reason for hope. But there's still much too much inequality and poverty. The Gini index of individual income inequality around the world lies somewhere between 60 and 70,18 and looking at wealth rather than income, the global Gini is probably closer to 90.19 The decline in total inequality at the individual level in recent decades masks mixed patterns for its two components: inequality between countries and inequality within countries (see figure 9-3). Inequality between countries rose after the industrial revolution because some got rich while others remained poor. The last few decades suggest, however, that integration has been leveraged—especially in East Asia—to reduce inequality by bringing up the bottom end of the global income distribution. But the pattern is quite different for inequality within countries, which has increased in recent decades. To explore inequality further, the sections that follow distinguish between develop
ed and developing countries.

  Figure 9-1: Global inequality versus average income and exports as % of GDP, 1820–2002

  Sources: Inequality among individuals and average income: Branko Milanovic, “Global Inequality and Global Inequality Extraction Ratio: The Story of the Last Two Centuries,” MPRA Paper 16535, July 31, 2009. Inequality among countries (weighted and unweighted): Branko Milanovic, “Worlds Apart: Measuring International and Global Inequality,” Powerpoint presentation, Carnegie Endowment for International Peace, Washington, DC, September 28, 2005. Exports as % of GDP: Angus Maddison, World Bank Development Indicators (WDI).

  Figure 9-2: Global income distribution by region, 1970 versus 2006

  Source: Adapted from Maxim Pinkovskiy and Xavier Sala-i-Martin, “Parametric Estimations of the World Distribution of Income,” NBER working paper 15433, October 2009.

  Figure 9-3: Inequality between versus within countries, 1970–2006

  Source: Adapted from Maxim Pinkovskiy and Xavier Sala-i-Martin, “Parametric Estimations of the World Distribution of Income,” NBER working paper 15433, October 2009.

  Developed Concerns

  Globalization's impact on workers in developed countries has aroused much concern these last few decades. Let me address three broad worries: that unskilled workers fall behind skilled workers; that workers overall lose out versus owners of capital; and that jobs become less secure. I'll start with the first. Inequality has increased in many developed countries over the last couple of decades.20 One country where this trend runs strong is the United States, where inequality has long exceeded that in other developed countries. The U.S. Gini rose from 40 in 1980 to 47 in 2007.21 Median inflation-adjusted earnings of adult males working full-time jobs haven't really risen since the 1970s,22 and the proportion of wage income reported on tax returns by the top 1 percent almost doubled from 1980 to 2005.23