Why Globalization Is Boosting Inequality in Developing Nations

by: Toro

The following article about the consequences of globalization appeared in Thursday's Wall Street Journal:

In some ways, globalization delivered as promised. But there was an unexpected consequence. As trade, foreign investment and technology have spread, the gap between economic haves and have-nots has frequently widened, not only in wealthy countries like the U.S. but in poorer ones like Mexico, Argentina, India and China as well. Many economists now say that the biggest winners by far are those with the education and skills to take advantage of new opportunities, leaving many lagging far behind. Incomes of low-skilled workers may rise, but incomes of skilled workers rise a lot faster.

Globalization deserves credit for helping lift many millions out of poverty and for improving standards of living of low-wage families. In developing countries around the world, globalization - defined as trading and participating in the global economy - has created a vibrant middle class that has elevated the standards of living for hundreds of millions of people. That's particularly true in China, where the incomes of low-skilled workers have consistently risen. The poor in countries like Vietnam and elsewhere in Southeast Asia have also benefited greatly since those countries have opened their economies. In many developing countries around the world, life expectancies and health care have improved, as have educational opportunities.

Latin America and China Charts

But because globalization is also creating more inequality, it is raising questions about how much inequality countries can bear and whether these gaps could ultimately produce a backlash that will undermine trade and investment liberalization around the world.

Many developing nations seem to be following in the footsteps of the U.S., where the income gap has grown sharply since the early 1970s. A 2006 study of Latin America, a region long marked by profound gaps between rich and poor, by World Bank economists Guillermo Perry and Marcelo Olarreaga found that the income divide deepened after economic liberalization in nine of the 12 countries examined.

Latin America chart

While that could partly be explained by Latin America's slow rate of economic growth, income gaps are widening in fast-growing Asian nations as well, including Thailand and India. It's even grown in the past decade in South Korea, a country long known for an egalitarian commitment to education.

Then there's China. One of the fastest-growing economies in the world has generated significant wage gains for its rank and file. Yet income inequality is also growing because of the huge gains being posted by the upper crust. Between 1984 and 2004, China's income inequality as measured by the Gini index - zero is perfect equality and 100 is perfect inequality - increased to 47 from 29, according to World Bank researchers Martin Ravallion and Shaohua Chen. From 2000 to 2005, per-capita income of the bottom 10% of urban households in China rose 26% while those at the top saw gains of 133%.

China v Mexican Growth

While Mexico hasn't experienced the spectacular growth of China, wages of those at the bottom 10th percentile of urban full-time workers increased 12% between 1987, when the country first took steps toward opening its economy, and 2004. Since 2000, the percentage of Mexicans living in extreme poverty also has fallen below 20% for the first time ever in the nation's history.

Even so, skilled workers in Mexico still earn far more relative to unskilled workers than they did before liberalization. In 2004, urban full-time workers at the top 10th percentile earned 4.7 times more than those at the bottom 10th, compared with four times as much in 1987, according to Columbia University economists Eric Verhoogen and Kensuke Teshima.

By other measures, income inequality is far greater. The World Bank, for instance, estimates that the top 10% of Mexicans accounted for 39% of the country's total spending in 2004, while the bottom 10% accounted for less than 2%. ...

How does globalization boost inequality? The question is too fresh to have definitive answers, but it's clear that international competition forces local firms to add skilled workers who can handle newer technology and shed workers who can't. Foreign firms bring new technology to developing nations and boost demand there for skilled workers by paying 10% to 20% more than domestic firms, says Dirk Willem te Velde, a research fellow at the Overseas Development Institute, a United Kingdom think tank.

Access to education also plays an important role. Developing nations rarely crank out enough college-trained workers to match growing demand, boosting the wages for fresh graduates. Unskilled workers who get laid off can't find retraining and add to the pool of workers looking for low-wage work.