Globalization, Growth, and Inequality

While there are many definitions of globalization, depending on the observers, their political leanings, areas of interests and geographical origins, the following can be considered as a broadly accepted definition: "Globalization is a process of interaction and integration among the people, companies, and governments of different nations, a process driven by international trade and investment and aided by information technology. This process has effects on the environment, on culture, on political systems, on economic development and prosperity, and on human physical well-being in societies around the world."¹ It also has several dimensions: economic, social, political, cultural, etc. which are also interrelated. This report focuses on economic globalization². Globalization, in the form of trade among the lands across continents, dates to Sumerian and Indus Valley civilizations. Economic historians cite the Silk Road, spanning a vast area between China and Europe as an example of globalization of trade. The period after the industrial revolution until the World War I is also highlighted as another example of relatively free flow of goods and capital across countries far apart. Globalization in the second half the 20th Century follows several decades of import substitution policies in developing countries particularly in Latin America proved to be less effective than export-oriented policies implemented by several East Asian countries around mid-1980s. By the beginning of the 1990s, many countries have embarked on export-oriented policies and started to reduce trade barriers. The policy framework that was labeled as the “Washington Consensus” advocated liberalization of trade, elimination of quantitative restrictions and replacement by low and uniform tariffs; liberalization of rules for foreign direct investment flows and reducing capital controls; and market determined exchange rates. Together with rapid technological advancement, particularly in communication and information technology, globalization took off between the early 1990s and 2007 when the global financial crisis brought it to an abrupt halt. Trade as a share of world GDP almost doubled from 16.8 percent to 31.3 percent during the twenty years between 1988 and 2008. Global capital flows have acted as both the causes and outcomes of globalization. They increased from 5.8 percent of global GDP in 1995 to 21.5 percent in 2007 and the stock of global financial assets went up from 256 percent of GDP to355 percent respectively. The period from 1990 to 2007 saw a very rapid growth at 8 percent a year in global financial assets in contrast to the 2008-2012 period when their growth slowed down to 1.9 percent a year. Because of its multifaceted character, measuring globalization has not been an easy task. One of the most commonly used measure is the KOF Index which covers the 1970-2014 period. It has five distinguishable trends. The increase was highest during 1994-2000 with an annual increase of 1.16, followed by 1988-1993 with an annual increase of 0.86, and 2001-2006 with an annual increase of 0.59. The increase was more modest for the 1970-1987 period with an annual increase of 0.32, and very low for the 2007-2014 period with an annual increase of 0.10. These indicate that the 1988-2006 period may be regarded as a period of rapid rate of globalization. While the impact of globalization on individual countries has been varied depending on their political and social environment, it is likely that globalization spurred economic growth, creating employment in developing countries and helped reduce absolute poverty across the globe, but empirical evidence is scant. The real-World GDP using purchasing power parity has four distinct periods in terms of growth rates, with average growth rates of 1.7% for the 1990-1994 period, 3.4% for the 1994-2001 period, 4.7% for the 2002-2008 period and 3.5% for the 2009-2016 period. A significant trend shift was observed in World inflation (measured using GDP deflator). The rate of increase (not the rate of inflation itself) in inflation was 1.9% during 1960-1975, and negative 0.2 during 1976-2016. This significant decrease was probably largely due to globalization with the increase in the number of less expensive places of production, and other factors such as decreases in commodity prices, and the peace dividend. An important effect was seen on poverty (measured as poverty headcount ratio at $1.90 a day, 2011 PPP, % of population). There was a negative trend in the poverty headcount ratio for the entire period, but significantly negative for the post 2005 period. In short, whether one uses flow of goods and services, flows of capital (foreign direct investment), or flow of labor (migration, and even tourism), there is a significant increase during the post 1990 period. A small econometric model with alternative scenarios clearly show that real GDP would have been higher with a higher KOF globalization index in all countries and the world. In addition, inflation would have been lower in the world economy. These results suggest positive effect of globalization on real GDP. The index of Economic Complexity attempts to measure the amount of productive knowledge that each country holds. This measure for productive knowledge can account income differences between the nations of the world and has the capacity to predict the growth rate. Results on growth and inflation equations are mixed in terms of identifying determinants. There is no clear dominance of the index of economic complexity, and world exports. Simulation results based on a small econometric model indicate that economic complexity indexes are higher with higher KOF indexes. The effects of globalization on employment cover a large and controversial area. Trade, foreign direct investment and technology transfer have differing effects on employment outcomes in both advanced and developing economies. The opponents of globalization in developed countries argue that trade with developing countries where wages and labor standards are low lead to unemployment at least in some sectors and regions. An important implication of this is increasing inequality. De-industrialization in developed countries is a result of the trade with labor surplus countries. The low labor standards put pressure on the labor standards in developed countries and start the process of ‘race to the bottom’. There is no theoretical framework providing clear explanations to these questions. The empirical findings are mixed. Trade causes sectoral shifts in employment; may lead to unemployment in some sectors. On the other hand, the culprit may be skill-biased technological change. The de-industrialization, that is, declining employment share of manufacturing, is result of more of a technological change and increasing productivity. There is no evidence of ‘race to the bottom’. The wage rates in developing countries tend to increase after some point, and FDI flows put pressure on domestic institutions for wage and labor standards to increase. Some authors find that trade policy is one of the aspects of globalization; other aspects such as immigration, capital flows, and technology transfers had more effect on employment and wages, and over-all well-being of labor force. The effects of globalization employment in developing countries are also mixed. In general, protected industries suffered, in competitive sectors employment increased. Countries differ in their management of integration with the world economy, speed and spread of liberalization and technological capabilities. Depending on these factors employment effects showed some variation. In some countries employment increased, however this was not a shift from less productive to more productive sectors. Consequently, these countries did not really benefit from globalization. Compared to earlier migration waves, this period has smaller waves. The sources of migration and destinations have changed. Migrant receiving developed countries, have stricter rules and controls. Current globalization is less friendly to unskilled migrants. So, migration is more in the form of brain drain, where educated and skilled people migrate. This has a negative effect on the migrating country labor force. Growing inequality is one of the developments most associated with globalization. There is not enough evidence on the causality between income distribution and globalization. On the other hand, this wave of globalization was accompanied by somewhat unexpected developments with respect to income distribution and related areas. Firstly, the world witnessed a dramatic decline in poverty. During the last three decades more than one billion people escaped poverty. There is more room for improvement, however this is still a great achievement. While China and Southern Asia took important steps in eradicating poverty, Sub-Saharan Africa is the region where more than 50 percent of the global poor still lives. The main factor in reducing poverty was the economic growth performance of these countries. This brings us to the second development that took place in the recent decades. During 1960s, it was a fact that the gap between advanced and developing countries would never close. However, some developing countries particularly those classified as emerging markets showed a remarkable growth performance. During the last decades, these countries had growth rates on average significantly higher than developed countries. Indeed, this did not close the gap, but these countries’ performance contributed to gap getting smaller. The convergence became a possibility. The inequality between countries got smaller. Again, not all developing countries showed this performance and benefited from the current wave of globalization. The third development is the increasing inequality within countries. According to the Kuznets Cycle economies would have more inequality in initial stages of development and inequality would decline as the economies mature. This was the experience of the developed countries. However, this wave of globalization was accompanied with increasing inequality in both developed and developing countries. In most of the developed countries the incomes of middle income groups stagnated while high income groups, particularly top 1 percent gained a lot. This also contributed to increasing inequality in the global distribution of income. Globally the losers of this process are the middle class in developed countries. The winners are the poor and middle-income groups of some developing countries such as China and top income groups of developed countries. These outcomes are considered as result of trade liberalization, financial deregulation, skill-biased technological change or rent-seeking activities. In line with the changes in the distribution of income the wealth distribution has also changed. The regional and global distribution of wealth show the same picture. The Human Development Index does not just rely on per capita gross domestic product to measure development. It is a more general measure of achievements in three key dimensions of human development: a long and healthy life, access to knowledge and a decent standard of living. It should be stressed that growth or human development is a long-run phenomenon, hence cross-country regressions rather than annual data on a single country may be a better approach. However, with the latter it was possible to see the effects in various countries. Scenarios with KOF indexes 10% higher than historical values are used to make comparisons. Here, results based on Scenario 2 – all KOF indexes (for the world and sample countries) are 10% higher. Results show that human development indexes are higher with higher globalization indexes. Most people in the world are better off in terms of income, health, and education compared with their situation in 1990s.