According to the mainstream liberal argument in most developed countries, public policy should try to increase social justice by evening up opportunities—equity—but should not try too hard to reduce income inequality. The exception is at the bottom: public policy should try to eliminate extreme poverty. For the rest, income inequality is the price that has to be paid for a dynamic and flexible economy.
In the liberal perspective, equity and efficiency turn out to be complements; the key to both is free markets and competition. Applied to the international economy, this approach says that aid may be appropriate for the poorest countries, but for others, what matters is open trade, open investment, and free capital movement, so that the country's producers have a level playing field with producers elsewhere. Insofar as the world adopts liberal market policies, growth in the poorer countries will be higher than otherwise, and high enough for many of them, over time, to catch up with living standards in the rich countries.
Martin Wolf, in Why Globalisation Works, puts it this way: "What the successful countries all share is a move towards the market economy, one in which private property rights, free enterprise and competition increasingly took the place of state ownership, planning and protection. They chose, however haltingly, the path of economic liberalisation and international integration. This is the heart of the matter. All else is commentary."
Wolf draws a general conclusion: "The failure of our world is not that there is too much globalisation, but that there is too little… if we want to raise the living standards of the poor of the world. Social democrats, classical liberals and democratic conservatives should unite to preserve and improve the liberal global economy against the enemies mustering both outside and inside the gates."
Growth, inequality and poverty
However, the evidence that a liberal policy regime is good for economic growth, poverty reduction and keeping a lid on income inequality is surprisingly uncompelling. If the liberal argument holds, we would expect the global shift towards free markets in the past 25 years to have raised the rate of world economic growth. Instead, there has been a slowdown in developed and developing countries.
Between the era of managed capitalism (roughly 1960-78) and the era of globalisation (roughly 1979-2000), the growth rate of world output fell by almost half, from 2.7 per cent to 1.5 per cent. (It is true that in the past few years the growth rate of world output has risen quite sharply—to 2.3 per cent for 2001-03—but not enough to change the basic pattern.) Many more countries experienced negative growth in the second period than in the first. In the case of Latin America, real per capita income grew by 80 per cent in the 19 years from 1960 to 1979, the era of "bad" import-substituting industrialisation; in the 24 years from 1980 to 2004, the era of "good" liberal policies, real per capita income grew by just 12 per cent. Indeed, all regions except for (non-Japan) Asia grew more slowly in the era of globalisation than in the era of managed capitalism.
As for income inequality between countries, the liberal argument says that it increased through the 1960s and 1970s, started to fall in the 1980s and continued to fall thereafter. This is true, as far as it goes. The definition of international income inequality uses countries' average income measured in purchasing power parity (PPP), weighted by population, and the Gini coefficient (a number between 0 and 1 that measures the degree of inequality in a distribution). When measured in this way, the Gini coefficient has indeed fallen since 1980, meaning that international income distribution has become more equal. But this is not the end of the story.
For one thing, the result depends entirely on China. If China is excluded, inequality between countries increased after 1980. So we cannot say that international income distribution has become more equal thanks to a process called globalisation. It is the result of one—massive—case, not a general trend. (Moreover, China has got richer with a form of capitalism very different from that enjoined by the liberal argument.)
Other measures show a trend towards rising inequality between countries. For example, the average income of countries in the top 90th percentile over that of countries in the bottom 10th percentile; or regional average income relative to the OECD average. Latin America's average income (in PPP) as a proportion of the developed world's has fallen precipitously since 1980 (see chart, next page), as it has in sub-Saharan Africa, eastern Europe and central Asia. East Asia is the exception: its proportion has risen since 1980, driven mainly by China. Thanks to east Asia the average income of the poor south as a whole relative to the rich north stopped falling in the 1990s.
When data on income distribution between countries is combined with data on distribution within countries, we get "global income distribution," or the distribution between all the world's individuals or households. Here the big story is that over half of the increase in world income or consumption over the 1990s—over half of world economic growth—accrued to individuals living on more than PPP $10,000 a year, most of them in the top half of the rich countries' income distribution; that is, to roughly 8 per cent of the world's population. Most of the rest accrued to the burgeoning middle class of China, living on around $3,000 a year. Hardly any of the additional consumption accrued to those living on less than about $1,000 a year.
As a result, the absolute income gaps are widening at a gallop. Yet our normal measures of inequality obscure this fact because they measure only relative income, not absolute income gaps. To see the difference, take two countries, A with average income of $10,000, and B with average income of $1,000. Their relative income is 10:1 and the absolute gap is $9,000. If A's income doubles to $20,000 income inequality remains constant provided B's increases to $2,000. In this case we conclude that income distribution has not become more unequal, even though the absolute gap widens from $9,000 to $18,000. No one questions that absolute income gaps have been increasing fast—for example, between the average income of the top 20 per cent and that of the bottom 20 per cent of the world, and also between the top 20 per cent and the intermediate 60 per cent. If, as is likely, people respond not only to relative income trends but also to trends in absolute gaps, then we should not be blind to the latter. All told, it is misleading to say that globalisation has caused a fall in world income inequality.
As for poverty, the liberal argument emphasises that the number of people living in extreme poverty (less than PPP $1 a day) has fallen substantially in the past 25 years, reversing the long-term trend. But again, the scale of the fall depends entirely on China. Remove China and the proportion of the world's population living on less than $1 a day decreased by only 9 per cent between 1981 and 2001. With $2 a day as the—hardly generous—poverty line and China excluded, the percentage reduction is next to nothing.
These are World Bank figures. But the Word Bank poverty numbers have a wide margin of error, and they may bias the poverty headcount downwards. The absolute poverty line of $1 a day is rather arbitrary. We can be fairly sure that if the bank used a basic needs poverty line instead, the number of absolute poor would rise. A recent study of Latin America by a UN economic commission shows that national extreme poverty rates, using poverty lines based on calorific and demographic characteristics, may be more than twice as high as those based on the World Bank's $1 a day line.
In short, the empirical evidence is unkind to the argument that the worldwide shift towards liberal policies over the past quarter century has generated higher economic growth, lower world income inequality and lower poverty. Quite a lot of evidence suggests the opposite. Without China, the impact of liberal globalisation on growth, income distribution and poverty would look dismal.
Why we should worry about inequality
The more globalised the world becomes, the more we should be concerned about how within-country inequalities also affect inequalities between countries.
Increases in world inequality above moderate levels may constrain world demand and thereby world growth. Widening income inequality within developing countries results in a higher propensity to import sophisticated goods and services from rich countries. Widening income inequality between countries—in particular the "missing middle" in world income distribution, only slowly being filled by China—dampens the demand for relatively unsophisticated goods that could be produced in developing countries, and limits developing countries' diversification out of commodity exports. As a result, demand for manufactured goods is below world supply capacity, resulting in intensifying competition and falling prices.
In turn, rising inequality between countries impacts directly on national political economy in the poorer states, as rich people who earlier compared themselves to others in their neighbourhood or nation now compare themselves to others in the US or Europe, and feel deprived and perhaps angry. Inequality above moderate levels may, for example, predispose the elites to become more corrupt as they compare themselves to elites in rich countries and squeeze their own populations in order to sustain a comparable living standard.
Migration is a function of inequality, since the fastest way for a poor person to get richer is to move from a poor country to a rich one. Widening inequality may increase the incentives for the educated people of poor countries to move to the rich countries and for the unskilled to seek illegal entry. But this pushes the emotive issue of immigration close to the top of the agenda in western countries.
The effects of inequality within and between countries also depend on prevailing norms. Where income inequality is thought to be the natural condition of man, negative effects can be expected to be lighter than where prevailing norms sanction equality and where the sense of relative deprivation is stronger. Norms of equity and democracy are being promoted by the prosperous democracies in the rest of the world, at the same time as the lived experience in much of that world belongs to a completely different reality.
The combination of income inequality between and within countries is moving the world towards an Anglo-Saxon type of capitalism. US hedge funds and private equity funds have become powerful actors in the world economy at large, including in Japan and Europe. They are using their shareholding power to demand changes in corporate governance law that would allow them more easily to buy up Japanese and European (especially German) companies which are cheap compared to US companies. They are cheap because a much lower proportion of the share of "value-added" goes to the providers of capital: 8 per cent to equity-holders and creditors and 85 per cent to employees (including managers) in Germany compared with 21 per cent and 68 per cent respectively in Britain. Stock market capitalisations adjust to give roughly equivalent returns, making Japanese and German firms look like real bargains for anyone determined to run them solely to maximise returns on capital. Liberal ideology argues that companies should be run so as to maximise "capital efficiency," which is persuasive to many in the business and political elites, even in countries like Japan and Germany that are awash with savings and—at least until recently—in the grip of demand-deficiency deflation, stagnant wages and falling consumer confidence.
For the OECD countries as a group, the share in business revenue that went to employees (as opposed to profits, dividends and so on) hovered around 70 per cent for decades after the second world war, increased to around 72 per cent by 1980, and then—with the policies of Reagan and Thatcher—fell to about 64 per cent today. On the other hand, the share of profits went up by 8 percentage points between 1980 and 2003. In the US, the share of household income accruing to the top 0.01 per cent of households fell from roughly 3 per cent in 1929 to 0.5 per cent by the early 1970s, flattened out, then—with globalisation—shot back up to reach 3 per cent by the early 2000s.
It is easy enough to suggest policies that would reverse this trend and improve equality of both opportunities and outcomes. In developed countries, more progressive taxation and earned income tax credits; in developing countries, land reform and more emphasis on expanding domestic demand, so relying less on export demand.
But elites, in normal times, see little self-interest in more equality. So the harder question concerns the politics of getting redistribution on to the agenda. Perhaps the new coalition of prominent developing countries, the G20, can shift the consensus on development strategy. Perhaps—a long shot—the "leftish" challenge in Latin America may spread out from Venezuela and Bolivia to gain momentum in Argentina, Chile, Brazil and Mexico.
The rules of the international development regime need to be changed to give governments of developing countries scope to accelerate their economy's move into higher value-added activities, as most of today's developed country governments did in the past. Elites of the G7 states can be expected to resist any such attempt when liberal globalisation is working so well for them.
