5. Inequalities within industrialised countries. 1 The ongoing redistribution of comparative advantages between North and South reveals different prospects for ...
GLOBALISATION AND INEQUALITIES Luc EYRAUD
A contribution to the G20 2002 workshop
This document has been realised by Mr. Luc Eyraud during his internship at the Treasury Department. Its conclusions and recommendations are the author's exclusive responsibility and does not engage the Ministry of Economy, Finance and Industry.
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We are grateful to François Bourguignon, Benoît Coeuré, Daniel Cohen, Pierre Jacquet, Michel Houdebine, Jean-Pierre Landau, Jacques Ould Aoudia, Stéphane Pallez et Jean Pesme for their comments.
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SUMMARY Inequalities between and within countries are showing a worrisome trend. They have soared during the past century owing to different national growth rates. The global inequality gap has widened significantly. ∗ The public frequently blames the aggravation of inequalities on globalisation. This report offers a more balanced opinion of liberalisation, which is first and foremost a powerful source of development. This said, liberalisation needs to be clearly defined: there are many ways to liberalise an economy and different methods have different consequences for inequalities. What are the characteristics of a successful liberalisation, i.e. a liberalisation which stimulates growth without aggravating internal inequalities. ∗ Between-country inequalities 1 It is difficult to establish a clear relation between growth of trade and the change in inequalities in income between countries: -
according to theory, trade and financial liberalisation has very different consequences for growth and therefore for international inequalities; empirically, it is difficult to isolate the impact of liberalisation on inequalities since inequalities are the result of many forces.
2 The ambiguous consequences of liberalisation are probably due to the existence of different types of liberalisation, not all of which have the same reductive impact on inequalities between countries. The question is therefore not so much whether or not to liberalise but what form of liberalisation should be pursued. The report discusses several criteria liberalisation needs to meet before it can help the developing countries to catch up to the rich countries: -
liberalisation needs to be robust: good governance and adequate institutions are necessary to cushion the shock triggered by liberalisation; liberalisation needs to be diversified and promote endeavours to find profitable specialisations; liberalisation needs to be gradual, particularly financial liberalisation; liberalisation needs to be reciprocal and allow poor countries to access the markets of the rich countries; liberalisation needs to be supported by official development assistance; liberalisation provides an opportunity to urge better allocation and more efficient use of development assistance.
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∗ Inequalities within developing countries While liberalisation is necessary to help the developing countries to close the gap and to reduce inequalities between countries, it creates a shock wave with consequences for distribution within countries. 1 Does trade and financial liberalisation improve or worsen the condition of the poorest? According to classical international trade theories, liberalisation can be expected to reduce inequalities within developing countries with an abundance of cheap production factors, since liberalisation prompts the developing countries to specialise in goods requiring a high proportion of such production factors. Practice appears to show that the growth of wealth induced by globalisation benefits the entire gamut of income distribution and so improves the income of the poor. These two observations should allow us to take an optimistic view of globalisation. However, it is not enough to assess the actual impact of globalisation on internal inequalities, for even when liberalisation does not directly affect inequalities, globalisation shows itself in certain global shocks with very negative consequences for poor populations (such as AIDS, the financial crisis, etc.). These effects prompt a severer view of globalisation, which can disproportionally weaken the poor populations in the developing countries. 2 Based on this diagnosis, we prefer policies designed to help the poor take maximum advantage of globalisation instead of merely undergoing its negative fallout. The fashionable approach to internal inequalities bears the hallmark of Sen's analysis of inequalities, which focuses on the fight against unequal opportunity. Policies against inequalities must promote economic, political and social integration of the poor classes. However, an increase in opportunities is not enough to solve the problem of inequalities since poverty is not just defined by hindrances to mobility but also by vulnerability and high exposure to risk. In other words, integration measures need to be complemented by measures for the protection of weakened populations. 3 Note the role of international development assistance in the fight against internal inequalities. Although internal, they are not only due to internal causes. The poor are directly affected by factors outside the national framework and not under their control: financial crises, diseases, conflicts, price instability, etc. ∗
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Inequalities within industrialised countries 1 The ongoing redistribution of comparative advantages between North and South reveals different prospects for different types of employment in the developed countries: skilled workers have ample opportunity while unskilled workers are affected by declining demand. Experts are arguing whether or not the marginalisation of unskilled labour is due to globalisation (because of competition from unskilled labour in the developing countries) or to the bias of technical progress in favour of skilled labour. These two explanations do not contradict one another. The new labour division (driven by globalisation) and the globalisation momentum combine to make globalisation a source of inequality: globalisation pushes the North to convert to the design and manufacture of high valueadded products requiring technical expertise, which rules out unskilled labour. 2 We have efficient tools to fight marginalisation of unskilled labour In the short term, support measures are required to offset the impact of globalisation on the market for unskilled labour; such measures would include redistribution, subsidies (reduction of social security charges on low wages) and reduced exposure to competition for the developing countries. In the long term, the problem must be dealt with at source by making sure that inequalities are not reduced by lowering the wage distribution basis. This can be done by raising qualification levels, encouraging retraining and disseminating the social achievements of the North in the South. 3 By contrast, declining tax revenues make it uncertain how the war on inequalities is to be financed. In fact, inequalities are affected by tax competition in two ways: - the resources earmarked for the fight against inequalities are reduced by global competition; - under pressure from competition, governments tend to raise taxation of the least mobile tax bases, which penalises the poorest. While reform proposals may differ (tax harmonisation, creation of a European status for the most mobile companies, etc.), they agree on one point: we need to adopt a concerted supranational approach to rethink the way the fight against inequalities is financed. ∗ In conclusion, it is urgently necessary to reduce inequalities. Traditional theory argues that the fight against inequalities is motivated by the need for equity and that it causes a loss of economic efficiency (it is commonly held that inequalities reflect differences in merit and are efficient and that their reduction - through redistribution - is distortive). 5
However, the focus of the debate has shifted from this traditional stance to cases in which efficiency depends on the reduction of inequalities. The relations between equity and efficiency are complex and their respective merits deserve to be re-examined.
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SUMMARY
Introduction Chapitre 1 Outline What is globalisation? What is inequality? Inequality between and within countries and global inequality Which inequalities? Factual inequalities, inequalities in condition and unequal opportunities Measuring inequalities
The problem
Chapitre 2 History of global isation and inequalities Globalisation or globalisations? The aggravation of inequalities International inequalities Internal inequalities Global inequalities
Inequalities and globalisation in the 19th century Within-country inequalities 1. New World and Old World 2. Developing countries Between-country inequalities
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Chapitre 3 Liberalisation an d convergence: an approach to between-country inequalities Opportunities of liberalisation Empirical approach 1. Trade liberalisation 2. Liberalisation in a the broad meaning of the term Theoretical approach 1. International trade theories 2. Growth theories 3. Institutional case
Risks of liberalisation Polarisation phenomena 1. Distance cost 2. Decrease in costs 3. Further analysis of polarisation phenomena Challenges of specialisation 1. Inequalities of specialisations 2. Endogeneous and exogeneous specialisations 3. What is a good specialisation? Financial risks and anticipations
What kind of liberalisation for the developing countries? Robust liberalisation Diversified liberalisation Careful liberalisation Reciprocal liberalisation Supported liberalisation 1. Why give aid? 2. Origins of failure of aid 3. Proposals
Conclusion
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Chapitre 4 Globalisation an d within-country inequalities in the developing countries The losers in the globalisation process Who are the losers in the globalisation process in the developing countries? 1. The poor 2. The peripheral regions Evolution of poverty
Responsibility of globalisation Theoretical approaches 1. Liberalisation and inequalities 2. Growth and inequalities Empirical studies 1. Effects of liberalisation on income 2. Other effects of liberalisation
Reducing inequalities The question of objectives Why should we reduce within-country inequalities? Instruments to fight inequalities 1. The problem 2. Integration measures 3. Protection measures 4. International assistance
Chapitre 5 Globalisation an d within-country inequalities in the developed countries The losers in the globalisation process First approach: growing remuneration inequalities Reasons for labour inequalities Labour and capital Outlook
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French responses to globalisation The adjustment process The perception of globalisation
Policies to fight inequalities Why fight internal inequalities? Methods to fight internal inequalities 1. Short-term measures 2. Long-term measures Financing the fight against inequalities 1. Threats besetting the tax instrument 2. Effects on inequalities 3. Proposals
Appendix 1: Interpretation of figures Appendix 2: International trade theories Appendix 3: growth and convergence
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Introduction The discussion of trade liberalisation has taken a whole new turn in recent years. The traditional question of gains from liberalisation (i.e. whether liberalisation creates wealth in a previously closed country) has come to be considered of secondary importance. There are two reasons for this: -
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the answer to this question does not show whether the developing countries are catching up. Even if a country on the whole gains by trade, there is nothing to suggest that the gain is sufficient to start closing the gap with the developed countries; moreover, this question does not factor in income distribution within countries. This is a problem. If globalisation combines slow income growth with serious aggravation of inequalities, it can worsen the living standard of the poorest despite the overall gain from liberalisation.
The current public and scientific debate focuses more specifically on an other issue, i.e. the distribution of wealth created by globalisation. Only a study of inequalities will be able to tell us who will be the winners and the losers in the globalisation process. The latter will be those who did not manage or were unable to seize the new opportunities offered by liberalisation. As the approach to globalisation therefore covers both the macroeconomic sphere (problems connected with growth) and the microeconomic sphere (problems connected with the distribution of growth) it raises at least three questions: -
does trade create wealth, i.e. does trade generate gains? how are these gains distributed between countries and can they be appropriated nationally? how is the wealth earned from trade distributed among a country's inhabitants?
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Chapter 1 Outline
What is globalisation? Strictly speaking, globalisation was originally defined as the boom in international trade since the Second World War. In fifty years, international trade is estimated to have multiplied by seventeen. During the same period, the average annual growth rate of international trade has remained above output growth. More generally, globalisation means internationalisation of trade, whether of goods, services or capital. Lastly and even more generally, globalisation refers to the gradual deregulation of various sectors (transportation, telecommunications, finance, etc.), permitting better international mobility of resources (human, technical, information, etc.) and increasing international competition. Globalisation is therefore a multidimensional phenomenon (human beings, capital, goods, information, etc.), whose impact on inequalities differs according to the sphere under review. For example, O'Rourke (2001) shows that trade and migrations made the New World more non-egalitarian in the 19th century but reduced inequalities in the Old World as capital movements had the reverse effect on inequalities of income. So the various aspects of globalisation need to be studied separately.
What is inequality? When we speak about inequalities, we need to specify both their subject (what kind of inequalities) and their object (inequalities between whom).
Inequality between and within countries and global inequality Three types of inequality are distinguished, depending on the population concerned: -
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The term "within-country" (or internal or intra-country) inequalities refers to inequalities between the inhabitants of a given country. This is what is meant when someone says that differences in income are decreasing or increasing in France. "Between-country" (or international or inter-country) inequalities mean inequalities between countries, measured as the per-capita difference in GDP between countries. This is the concept one has in mind when asking whether or not the developing countries are converging towards the industrialised countries or when comparing the living standard of countries. 12
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Lastly, the term "global" inequalities combines the above two concepts. It means inequality (e.g. of income) between all people in the world, regardless of their country of origin. In other words, global inequalities are measured like internal inequalities but targeted at the world population.
The effects of globalisation on global inequalities are definitely the most interesting to study but also the most difficult to evaluate. Complex configurations may emerge. Diminishing global inequalities may combine with increase in inequalities within the poor countries if their growth rate is strong enough. In this case, aggravation of withincountry inequalities is more than offset by the reduction of between-country inequalities. Note: the current consensus is that global inequalities are mainly due to between-country inequalities. Only one-third is believed to be due to internal inequalities1. Note: it is not always relevant to distinguish between internal and international inequalities, as shown by the following example: international inequalities are partly caused by the mobility of the factors involved (flight of human resources from poor to rich countries). The drain of skilled labour lowers the tax base in the poorest countries, which limits the scope of redistribution policies and so worsens internal inequalities.
Which inequalities? The difficulty in studying inequalities is not just due to the diversity of concepts discussed above but also to the choice of criteria adopted to measure inequalities. Inequalities are normally determined by calculating the difference in financial income, but this is a relatively limited approach. In the mid-90s, the World Bank embarked on a vast programme to consult the poor within the framework of the PPA (Participatory Poverty Assessment) in order to discover and factor in the viewpoint of every layer of society and to get all stakeholders to monitor the implemented policies. These sociological surveys give a multidimensional perception of inequalities and show that a purely monetary approach does not cover every aspect. . First of all, there are other objective non-monetary criteria to measure inequalities, notably access to health facilities, education and human capital. Secondly, inequality has a subjective ingredient (people feel successful or unsuccessful, dominant or dominated), which is rarely taken into consideration in surveys. This multifaceted approach would not raise problems if the inequalities measured according to different criteria would overlap. However, this is not the case. Razafindrakoto and Roubaud (2000) have shown that a 1998 survey to measure poverty in the capital of Madagascar, using seven objective and subjective measurement criteria, 1
See Bourguignon et Morrisson (1999).
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failed to isolate a poor population group, as only 2% of the panel met all seven criteria while 78% of the population suffered from at least one form of poverty. As inequality is multi-dimensional, standard-of-living measurement criteria such as those of the UNPD are more relevant. The human development indicator factors in several qualitative development criteria, i.e. life expectancy at birth, the gross education rate and PPP per-capita GDP.
Factual inequalities, inequalities in condition and unequal opportunities Two main approaches to inequalities can be distinguished: welfarism and opportunity. According to the welfarist school, inequalities are reduced by offering everyone certain guaranteed outcomes based on preferences agreed by society, such as a minimum wage. The opportunity approach popularised by Rawls (1971) is based on criticism of welfarism, which does not respect the diversity of individual preferences. It stresses equal initial opportunity instead of outcomes. This gives a rather original vision of policies to reduce inequalities: -
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John Roemer (1998) proposes equalising the individual positions at the start of social competition. So ex post inequalities will be attributable to individual responsibility (merit) and the reason for justifiable inequalities. Amartya Sen (1992) defines the concept of "absolute poverty" as deprivation of the minimum resources (capabilities) necessary for the free exercise of the inalienable human rights to food and medical care, to select one's profession according to one's capacities and to participate in society. According to Sen, the objective of development policies should be to raise the poorest above this poverty threshold since this alone would allow them to recover the capabilities universally required to take their chances. Poverty is considered a trap it is impossible to get out of.
According to this second approach, inequalities are reduced by pursuing a policy designed to equalise the initial endowments (redistribution occurs once and for all at inception) and by improving social mobility (policies on education, nutrition and so on) rather than by reducing de-facto inequalities. In this case, some inequalities may remain (since this approach does not address inequalities of merit). Note that the reduction of unequal opportunities is not necessarily compatible with the reduction of de-facto inequalities: a high degree of monetary poverty is compatible with high social mobility while a decrease in poverty may go hand in hand with an increase in the risk of becoming poor. Hence there may be a quandary between equalisation of opportunities and greater inequality of outcomes.
Measuring inequalities 14
The basic yardstick for international inequalities is per-capita GDP in terms of purchasing power parity. This benchmark offers two advantages, since it factors in both the demographic weight of each country and price differences, which makes comparisons between countries relevant. It is also used to measure a country's internal inequalities. Indeed, using this gauge, it is possible to calculate the Gini coefficient and to display the interdecile income spreads using the Lorenz curve. The Lorenz curve is a simple representation of the GDP distribution within a population. The ordinate axis shows the cumulative percentage of national income while the abscissa shows the cumulative percentage of the target population. The bisector indicates the egalitarian distribution of income. The Lorenz curve is found by determining the fraction of income for each decile. The more non-egalitarian the distribution of income, the farther the distance between the curve and the bisector. The Gini coefficient corresponds to the ratio of the surface between the Lorenz curve and the bisector to the total surface of the half-square bordered by the bisector. Its value ranges from 0 to 1. The closer the index is to 1, the more non-egalitarian is the distribution of income.
The problem The starting point of this analysis is a general consensus (sometimes said to be maintained by the Bretton Woods institutions2) that: 1 The problems facing countries have internal causes, such as civil war, poor governance, ethnic and religious fragmentation, lack of national good governance. Globalisation is not guilty. 2 On the contrary, globalisation is beneficial and a powerful factor to reduce betweencountry inequalities and within countries. These assumptions are echoed in the Australian report Globalisation and poverty; turning the corner. Its underlying observation is that the poorest countries have posted little growth of trade, political instability and internal conflicts, whereas the countries where poverty has decreased are characterised by growing liberalisation and peace. It supports this with many examples of countries whose problems have internal causes independent from globalisation. The report concludes that development will not take less globalisation but the construction of robust institutions (designed to foster good economic performances and to reduce the risk of civil war) and the pursuit of "good" national policy choices. 2
The BWIs have recently changed their position considerably, as reflected inter alia in their initiative to fight poverty.
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In contrast, certain NGOs blame the "mainstream thinking" of the Bretton Woods institutions. They believe that globalisation plays into the hand of the rich countries and aggravates internal inequalities. Many theorists3 are also opposed to the "Washington consensus" insofar as they make pessimistic diagnoses for the poor countries. They argue that these countries are stuck in underdevelopment and that liberalisation will not allow them to get out of such traps (on the contrary, they believe that liberalisation will push them even further to the sideline). The report aims to determine the extent to which globalisation is responsible for convergence between countries and for the distribution of trade gains within countries. It endeavours to show that there is a golden mean between the general consensus and the extreme positions adopted by certain NGOs.
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For exemple Birdsall (2002).
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Chapter 2 History of globalisation and inequalities This analysis begins with a review of the facts, since discussions dealing with globalisation and inequalities are frequently based on false ideas or fantastic interpretations of the figures. It is important to remember that the current globalisation process is not without precedent in history, that it is far from total and that there is no evidence that inequalities have increased in the last ten years.
Globalisation or globalisations? Since the 19th century, trade has never developed in a straight line but over a series of expansion and contraction periods. Globalisation is neither an inevitable phenomenon nor a unique phenomenon in history. It should be remembered that the world at the end of the 19th century was at least as integrated as it is today4. Trade seems to be more integrated today than in the last century (e.g. current tariffs on manufactured products are lower than in 1913). However, there are important exceptions (Great Britain, certain Asian countries, etc.). Moreover, the rich countries protect their agriculture nowadays more carefully than in the previous century and non-tariff barriers are higher. By contrast, capital movements have never reached the volumes recorded in the 19th century. First, no OECD country exports as much capital as a century ago (as a percentage of GDP) and, secondly, the capital markets have only recently begun to return to the degree of integration achieved at the end of the 19th century. But it is especially in terms of migration that the ongoing globalisation process lags far behind the globalisation wave of the 19th century. Between 1820 and 1914, 60 million Europeans emigrated to the New World!
The aggravation of inequalities In 1999, Bourguignon and Morrisson conducted a benchmark historic study of inequalities (1999), which described the evolution of inequalities from 1820 to 1992 and proposed a breakdown of global inequalities based on a distinction between inter-country inequalities and internal inequalities.
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For further data, see O’Rourke (2001).
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Inequality within and between countries (Theil) 0,9
0,8
Theil 0,7
0,6
Within
0,5
0,4
0,3
Between (International)
0,2
0,1
0 1820
1840
1860
1880
1900
1920
1940
1960
1980
2000
Before making a detailed study of inequalities, in the short and medium term, it is especially the very high level of inequalities which raises a problem. This should not be overlooked in the following discussions.
International inequalities
Inequalities of income between countries increased during the past century (based on comparison of the figures in 1900 and 2000) due to different national growth rates. The industrialised countries reported higher average growth rates during the 20th century than the developing countries. The debate focuses in fact on the recent period. According to Bourguignon and Morrisson (1999), international inequalities have steadily increased in the last thirty years, but this position is disputed. Recent studies5 indicate that between-country inequalities have decreased since the 70s owing to the rapid growth of many poor countries, particularly densely populated countries such as China, India and Indonesia (compared with the industrialised countries, whose growth rates have declined since the 80s and whose weight in the world population has decreased). More exactly, the decrease has been of relative inequalities: the growth rates of the developing countries are on average higher than those of the industrialised countries, allowing them to narrow the gap, though not enough to bring about absolute convergence between the income of the poor countries and the rich countries. Two hundred years of divergence cannot be undone in a few years. The absolute gap in income between the rich and the poor countries will take very long to close. 5
Schultz (1998) for example.
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It should nevertheless be remembered that international inequality measurements cover widely varying realities: there is neither global convergence nor global divergence but only a catching up by a few countries (such as China) while the rest of the Third World is marginalized (particularly African countries). Lutz (2001) shows that, since 1960, the gap has not only tended to widen between the richest countries and the poorest countries but also between the middle-income countries and the poorest countries and that there is a convergence between the rich countries and the middle-income countries. We are therefore witnessing simultaneous divergence at a global level and convergence within a group of relatively rich countries. Geographically, the following trends can be isolated (see the following table6): for the last twenty years, Asia has been catching up with the rich countries, helped by faster growth of average per-capita income. By contrast, Africa and the poorest countries are becoming marginalized (Sub-Saharan Africa reported a 0.2% decline p.a. of per-capita GDP throughout the 90s) while Latin America, confronted with internal difficulties, has trouble overcoming chronic debt overhang (per-capita GDP increased by 1.7% p.a. during the 90s, compared with 1.9% for the rich countries)7. Per capita income growth – Average for different country groups Average per income (PPP$) 1965 1981 China 577 966 India 751 908 Poorest8 629 1,095 Second poorest 1,436 2,550
capita Average annual growth income (%) 1997 1965-1981 1981-1997 2387 3.27 5.82 1624 1.19 3.70 1,349 3.52 1.31 3,634 3.65 2.24
in per capita Share of world population (%) 1965-1997 1965 1981 1997 4.54 22 22 21 2.44 15 16 17 2.41 11 13 15 2.94 14 15 16
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Intermediate10 Richest11
3,730 7,221 8,983 12,716
Sample
2,497 3,523
9,407 4.21 15,99 2.20 7 4,618 2.16
1.67 1.45
2.93 1.82
8 14
8 12
7 11
1.72
1.94
85
85
86
While between-country inequalities have therefore increased during the past century, the trend may have been turning around in recent years. However, this simple observation gives only a very partial view of inequalities. First, because it covers different experiences. Next, because comparison of the per-capita income of each country (i.e. by adding up the income of a country’s inhabitants) conceals within-country inequalities. It
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Table taken from Melchior (2001). Data from the World bank report (2000). 8 31 countries. Income less than 1,000 PPP$ in 1965. 9 39 countries. Income between 1,000 and 2,000 PPP$ in 1965. 10 22 countries. Income between 2,000 and 5,000 PPP$ in 1965. 11 21 countries. Income over 5,000 PPP$ in 1965. 7
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is therefore necessary to take the analysis one step further and to examine within-country inequalities. Internal inequalities Within-country inequalities decreased slightly in the 19th and 20th centuries, particularly between the two World Wars. But once again this average conceals different trends between regions (e.g. cities/countryside, seaboard/interior for China) and between countries12. Trends vary in the industrialised countries. For example, inequalities of income in Great Britain increased from 1977 to 1990, when the Gini coefficient of disposable income rose from 0.28 to 0.4. The CAE report (2001) on the French situation indicates that inequalities in individual income are less than in the 60s, especially decreasing in the 70s (though the gap started to grow again in the 90s). The French Gini coefficient is around 0.3 (0.33 according to the World Bank; 0.29 according to the CAE report), compared with over 0.4 in the United States (0.41 according to the World Bank; 0.45 according to the CAE). In the developing countries, the degree of internal inequality - generally higher than in the OECD countries - varies from country to country. The Gini coefficient varies considerably between countries and here too there have been diverging trends in recent years. For example, Mexico and Brazil have experienced contrasting evolutions. Between 1976 and 1996, the Gini coefficient fell from 0.62 to 0.59 in Brazil. By contrast, between 1984 and 1994 it rose from 0.49 to 0.55 in Mexico. Internal inequalities have increased in certain Asian countries, particularly China, even though poverty has decreased (between 1987 and 1998, the fraction of the Chinese population living on less than one US dollar a day fell by 30% even though the population increased by 160 million people during this same period).
Global inequalities The change in global inequalities is mainly due to differences in the national income of countries and to a lesser extent to disparities in income within countries. Thus, global inequalities have increased during the past century owing to worsening between-country inequalities. This trend was nevertheless halted between the two World Wars when internal inequalities fell steeply (although between-country inequalities continued to increase). There is therefore clearly a divergence over a long period. According to Schultz (1998), however, between-country inequalities have sufficiently decreased since the middle of the 12
See the CAE report (2001).
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70s to drive back global inequalities. Global inequalities are apparently diminishing at present, though this position is the subject of debate among economists. Once again, we would have a more relevant vision of global inequalities if we reasoned in terms of groups of countries. For instance, Dollar (2001) shows that inequalities between individuals have diminished in the OECD countries since the 80s and continue to diminish if we add the post-80 globalisers. By contrast, inequalities have worsened in the developing countries due to the sharply different growth rates. Dollar concludes that the "great divergence" is not to be found between developed countries and underdeveloped countries but between two types of underdeveloped countries (integrated countries and marginalized countries). This point is discussed in a later chapter.
Inequalities and globalisation in the 19th century The end of the 19th century saw sharply lower transportation costs, large-scale emigration from the Old World to the New and large capital flows from the Old to the New World. What impact did each of these globalisation aspects have on the distribution of income between and within countries?13
Within-country inequalities
1. New World and Old World Simply put, the world had only two main resources in the 19th century, labour and land. Consequently, goods were either labour-intensive14 (manufactured goods) or soilintensive (agricultural products). The world was further divided into two major areas: the New World, whose abundant arable land allowed it to trade food for goods manufactured in the Old World, and the Old World, which had a large labour force. Observation shows that relative and absolute remunerations converged towards the end of the 19th century, for which there are two explanations15: -
Comparison of the trade structure between the two areas shows that the countries of the New World, which had abundant, inexpensive land, exported agricultural products to Europe and that Europe, where labour wages were lower, exported manufactured goods to the New World. According to the classical theory of trade (Heckscher-Ohlin-Samuelson theory16), this trade narrowed the gap between
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For further data, see O’Rourke (2001). A labour-intensive good is a good whose manufacture requires relatively more work than other production factors. 15 Note that capital movements have been a divergence factor insofar as the capital left Europe, where wages were low, for the New World, where wages were high, which may have increased the w/r gap. 16 See appendix 3. 14
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European and American wages and simultaneously boosted the price of land in the United States. The massive migrations at the end of the 19th century also helped close the wage gap. As the labour force dwindled sharply in European countries with high emigration rates (Ireland, Norway and Italy), the wage/rent ratio rose in Europe. Conversely, as the number of workers on the US market soared, this ratio fell in America.
What was the impact of these shifts in the price of the factors involved on inequality? At the time, landowners were normally the biggest earners while workers were part of the poorest populations. As a result, globalisation made Europe more egalitarian (by raising the wage/rent ratio) and the New World less egalitarian. Moreover, as most migrants had few skills, emigration diminished remunerations in the New World (aggravating inequalities) and improved wages in Europe (reducing inequalities). Thus, globalisation made the poor and non-egalitarian Old World more egalitarian and the wealthy and egalitarian New World less egalitarian.
2. Developing countries According to the HOS theory, globalisation should worsen inequalities in wealthy and egalitarian countries and diminish inequalities in poor and non-egalitarian countries. As we have seen, globalisation aggravated inequalities in the New World in the 19th century, which confirms this theory. By contrast, countries belonging to the Third World (at the time Argentina, Brazil, Uruguay, Mexico, Japan, India, Indonesia, Philippines, Taiwan, Thailand and so on) paradoxically experienced growing within inequalities at the time. In Latin America, this was probably due to the fact that globalisation – as in the rest of the New World – lowered the wage/rent ratio, which aggravated inequalities. Moreover, such countries as Argentina were not low-income countries (according to late-19thcentury standards). The situation was more surprising in Asia. Inequality increased everywhere, even in the poorest countries. Moreover, inequality did not only increase in countries with abundant land (such as Thailand), where the wage/rent ratio had gone down, but also in countries with a shortage of land (such as Japan and Taiwan) where the ratio rose. This was probably due to the fact that inequalities are not only linked to globalisation but also to such factors as demographics and technical developments. In conclusion, 19th-century globalisation did not decrease inequalities within the developing countries.
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Between-country inequalities Between-country inequalities became worse at the end of the 19th century. This observation covers many different national experiences. While for instance the Scandinavian countries converged very quickly with the leaders at the time (EU and GB), other countries, such as Spain and Portugal, did not converge at all. Should we blame globalisation for this? In-depth studies have shown that the inability of Spain and Portugal to converge was due to inadequate liberalisation (incapacity to import sufficient capital and to "export" sufficient people), whereas globalisation allowed a number of marginal European countries to converge towards the centre. The key factor was migration, which accounted for 70% of total convergence (trade seriously worsened within-country inequalities but had less impact on between-country inequalities). In other words, the increase in between-country inequalities at the end of the 19th century was apparently not due to globalisation; on the contrary, the migration accompanying globalisation was a factor of convergence.
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Chapter 3 Liberalisation and convergence: an approach to between-country inequalities Certain official documents appear to consider globalisation clearly beneficial for the world's countries and to blame the problem only on the way profits are shared within countries (limiting the issue to the question which policies should be implemented to distribute growth fairly among all economic agents). This position is theoretically naïve and empirically wrong since trade does not benefit all countries equally. Analysis of between-country inequalities is therefore a sine qua non for analysis of within-country inequalities. This chapter begins with the observation that closed developing countries cannot catch up to rich countries and that efficient countries generally conduct exports strategies. Liberalisation appears to be a condition for reducing inequalities between countries. However, liberalisation may also have negative effects. This paradox (the ambiguity of liberalisation) can be solved by looking at the problem from another angle and recognising that there are several types of liberalisation, some of which are better than others for development.
Opportunities of liberalisation Empirical and theoretical studies confirm the main role of liberalisation in the development process. Empirical approach In an article published in 200117, David Dollar isolates two groups of developing countries, distinguished by their growth rate and trade liberalisation. Studying the third globalisation wage of the 80s (after the waves from 1870 to 1914 and from 1950 to 1980), characterised by progress in the area of transportation and technology and by liberalisation of trade and international investment, he identified a group of 24 newly globalised countries (the "post-1980 globalisers") (with 3 billion inhabitants), which have clearly managed to take advantage of globalisation by opening themselves up to international trade. This group includes China, India, Brazil, Mexico and Hungary. The per-capita growth rate of this group of countries rose from 1% in the 60s to 3% in the 70s, 4% in the 80s and 5% in the 90s. Their average growth rate is now higher than that of the developed countries, which means that they are catching up. By contrast, another group of countries with 2 billion inhabitants, which the author calls "non-globalisers", mainly consisting of African countries, went into a decline in the 80s and 90s, reflected in negative average per-capita income growth. The economies of these 17
"Trade, Growth and Poverty", World Bank, co-authored with Aart Kraay.
24
countries are supported by a few commodities, which lays them particularly open to trade shocks. According to Dollar, these countries will only be able to diversify their exports if they have access to the world markets. The observation of a correlation between the degree of liberalisation and strong growth suggests a causality: has faster trade growth allowed certain countries to grow faster and to converge with the rich countries?
1. Trade liberalisation A whole economic literature is devoted to studying the impact of trade liberalisation on a country's growth. The underlying issue of such studies is the problem of economic convergence: does the reduction of trade barriers allow the poor countries to catch up to the rich countries? The reference article on this issue was written in 1995 by Sachs and Warner, who endeavour to show a robust empirical relation between liberalisation and growth during the period from 1970 to 1989. They show that open countries grow faster than closed countries and that the poor countries must be liberalised to catch up to the rich countries. This article has been criticised by Rodrik and Rodriguez (2000), who stress the difficulty of showing a clear relation between growth and liberalisation. It is difficult to separate the impact of trade policy from the impact of other policies correlated to growth (it is first necessary to determine the impact of such other policies). There is no assurance that trade policy and growth are not linked to a third explanatory variable of economic policy. Moreover, liberalisation measures reflect at best a dynamic export market but never a frank trade liberalisation policy. In fact, the results of liberalisation rather than the liberalisation policy itself are used as an explanatory variable. Econometrically, the question is therefore still not settled. The article by Rodrik and Rodriguez continues to spark a heated debate…
2. Liberalisation in the broad meaning of the term We should not neglect the other dimensions of globalisation, which can also influence the growth rate. O'Rourke has pointed out that the aspect of globalisation with the most impact on convergence in the 19th century were the migrations, not trade18. In today's world, migrations can apparently no longer play the same role. Will capital flows take over? The role of capital movements in complementing goods trade is discussed by many authors. Economic theory is in favour of direct investment in complement to trade liberalisation: Dollar and Kraay (2001) have shown that trade and direct investment are correlated to 18
Certain authors believe that only large migration movements will allow the poor countries to catch up in our age.
25
acceleration of growth (but that the investment rate alone is not correlated to growth). It seems that globalisation proper (trade liberalisation) is not enough to explain growth but that globalisation in the broad meaning of the term (goods trade and direct investment) stimulates growth. The Irish school is frequently mentioned as a successful development model based on liberalisation of foreign trade. Ireland's exceptional growth is due to a combination of trade integration, strong FDI inflows (as the foreign companies that use Ireland as a base for selling their products in the European community bypass tariff barriers) and structural funds (of which Ireland has received more than most other countries). Note: Considering that a country's alternatives are not to open or not to open but when to liberalise, this correlation may be tautological: if countries are waiting until they are ready for liberalisation, liberalisation logically goes hand in hand with growth. The problem must therefore be formulated differently and include the moment of liberalisation19.
Theoretical approach Empirically, liberalisation seems to go hand in hand with the reduction of betweencountry inequalities. The search for a workable approach should therefore continue to focus on growth-friendly liberalisation channels. 1. International trade theories Arguments in favour of free trade are especially found in international trade theories. Classical international trade theory stresses the merits of specialisation: countries with a liberalisation policy specialise in goods where they have a comparative advantage: they reallocate their resources to the production of certain export goods and they import goods no longer produced locally at lower cost than the price they would have been able to obtain for locally manufactured products. This theory of comparative advantages shows that specialisation raises the level of income but does not prove that the poor countries will converge towards the rich countries. Any liberalisation gains are obtained once and for all and do not lastingly change the growth path. On the contrary, new international trade theories insist on the dynamic gains generated by liberalisation. These theories have been developed to explain the existence of trade in similar products between comparable countries, i.e. intra-industry trade20 arising thanks to the resultant economies of scale and product differentiation.
19
See chapter 3 "a careful liberalisation" for developments. These theories neatly cover North-North trade, which is a form of intra-industry trade, while North-South trade remains inter-industry trade.
20
26
This type of trade has the following characteristics: -
-
-
Product differentiation: all markets are segmented since businesses cannot establish a position without a distinctive offer. In doing so, they cater to consumer demand for differences (taste for variety and ideal variety). Customers choose brands according to their purchasing power and taste. Thus, trade focuses on products that are distinctive enough to give producers a degree of monopoly power (in a given market segment); increasing returns, which can have two origins: size (a country benefits from economies of scale by adding new outlets) and experience (the more one produces the better one knows how to produce; this is known as the "learning curve"); but although product differentiation and increasing returns help make competition imperfect, a certain competition remains due to the free entrance to the market and to the relative substitutability of goods.
A good commercial policy is to find a niche on a "winning" market (e.g. by producing a cell phone chip), which will allow a country to converge by "holding on" to this dynamic market and taking advantage of the economies of scale in its segment. Thus, international trade theories hold that liberalisation temporarily or permanently alters the growth rate in the following two ways: - specialisation, requiring optimum reallocation of resources; - enlargement of the market, generating economies of scale and enriching the variety of consumer products.
2. Growth theories A more traditional way of tackling the problem of convergence21 is to place it within the framework of growth theories. These growth models allow clear identification of the main determinants of growth (accumulation of production factors and technical progress). The impact of liberalisation can be studied in such models by describing it as a shock for one of the engines of growth. ∗ In the Solow model, long-term growth is only influenced by population growth and technical progress. There is reason to think that liberalisation may influence the pace of technical progress, since it is an "opening to ideas". Direct investment is often given as an example of this.
21
The term convergence means that poor countries catch up with rich countries.
27
Direct investment involves transfer of technologies. A country receiving direct investment benefits from the technology of the country which exports the capital. There are nevertheless threshold effects: a minimum development level (local human resources and technological capacity) appears necessary before an economy can "absorb" imported technologies. ∗ Another determinant of growth is the accumulation of production factors. According to certain empirical studies22, this determinant is even more decisive than the first. Liberalisation contributes resources (labour and capital) with an impact on the growth rate. In the short term, accumulation enables poor countries to catch up through due to a quantitative impact. In the Solow model, inflow of foreign capital allows a country to reach its stationary state faster but does not change its growth path due to the declining marginal productivity of capital. In the long term, growth depends on exogenous factors (population growth and technical progress) instead of the accumulation behaviour of economic agents. Thus, while liberalisation enlarges production capacity and so accelerates growth, this effect runs out of steam over time. In the long term, the externalities generated by accumulation can accelerate growth. In certain endogenous growth models23, the increase in the quantity of capital raises the productivity of labour. The expression "learning by doing" is used to describe the fact that the learning process and the accumulation of knowledge occur gradually as activity continues to grow. According to this theory, the per-capita accumulation of capital does not drift towards zero in the long term: growth is endogenous and maintains itself. Liberalisation of capital flows helps overcome marginal domestic savings and so allows the accumulation of more capital than the domestic market could have generated. Thus it can help the developing countries to catch up and even to speed up their long-term growth (according to theory). Note We could refer to another theory to assess the effects of liberalisation on capital accumulation : the theory of the double deficit, which dates from the 60s. This approach stresses the fact that growth depends on two trade factors. The first factor is the resources necessary for investment (i.e. to prepare production capacities): external capital flows allow the developing countries to invest more than they can save, which overcomes their savings deficit. 22
Young (1992, 1994), who applies Solow's breakdown to the "four tigers", shows that the growth of these countries is linked not so much to technical progress as to the accumulation of production factors. As Paul Krugman wrote in 1998, the tigers owe their success to perspiration rather than inspiration. 23 See Romer (1986).
28
The second deficit is the currency deficit, linked to the fact that investment (and therefore growth) in a developing country depends on imported capital goods and intermediate goods: even if domestic savings are enough to finance investment, a country can only invest if it has enough currencies to pay for the necessary imports. Indeed, investment is hampered even more by lack of currency than by lack of domestic savings, since lack of currency means that production capacities are underused, limiting growth to a level below its potential. This currency deficit can be overcome by capital inflows, which are necessary for growth. The theory of the double deficit therefore illustrates the idea that a country needs to trade with other countries in order to stimulate growth (through investment).
Thus, the growth theories identify two ways in which liberalisation stimulates growth: - acceleration of the rate of technical progress. - accumulation of production factors.
3. Institutional case A developing country getting poised for world trade gets access to the market economy. Market economy implies first of all a certain regulation of economic activity by means of market mechanisms. Flexible pricing is essential for this type of regulation. In addition to their capacity to adjust supply and demand, prices reflect scarcity and send signals to economic agents. For example, price hikes give a signal to producers, who will step up production (in the hope of larger profits), i.e. they will invest and hire. Liberalisation gives countries access to automatic price-led regulation, which is frequently more efficient than centralised, authoritarian regulation. For example, the USSR used controlled prices, which led to all kinds of breakdowns. This was especially visible in the management of its agriculture (famine, self consumption, low productivity…). ∗ A market economy also means a body of rules which must be accepted to remain competitive on the world market. These include quality constraints (existence of standards) and price constraints (producers are price takers, not price makers). Thus, the market economy is opposed to an economy of unbridled corruption, despotism, nepotism and so on. In a market economy, these shortcomings may exist but are necessarily limited since they are punished by the market.. A market economy therefore implies a body of rules designed to reduce the arbitrary aspect of other types of regulation. ∗
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A market economy also means a group of institutions. Economists have buried the myth of a "pure" market. Correct operation of the market depends on the existence of institutions (statistics institutes, regulatory authorities, etc.) that dictate codes and standards and without which there would be no market. All this merely revives an old debate on political economics between the followers of Hobbes, according to whom there can be no order without a leviathan forcing individual freedoms, and the advocates of the "invisible hand" hypothesis, who hold that the same order can be achieved without subjection by letting individual interests express themselves. This opposition is actually unfounded since even the second position implies the existence of institutions without which there would be no Walrasian agreement. We are thinking here of the auctioneer but there is a whole set of institutions to keep a "self"regulated market in existence. In other words, a market economy also means institutions to support the economy and make it viable. It is nevertheless true that liberalisation is not enough to import such institutions concretely. Sudden and unregulated liberalisation does not promote development, as comparison of the Chinese and the Russian ways. Stiglitz (2002) stresses the importance of government and an institutional framework, also for privatisation: privatisations have aggravated corruption in Russian society, at least initially. It seems therefore that development is stimulated by a combination of liberalisation and institutions. Liberalisation gives access to institutions and, reciprocally, institutions support liberalisation.
Trade therefore not only makes it possible to gain market share but also to build a market structure with value-for-money criteria, mechanisms to transmit information and support from institutions.
Risks of liberalisation As we shall see, globalisation can also be a factor of inequalities between countries. This contradicts: - the consensus that the problems of the developing countries are solely due to internal causes; - a tradition of economic theory based on the idea of convergence between rich countries and poor countries24.
Polarisation phenomena Geographical economy gives an original explanation to divergences between countries.
24
See appendix 3.
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1. Distance cost Geographical economy is advocated by those who factor in the gains and costs of globalisation to show that costs are not necessarily divided equally among the players: globalisation costs are mostly borne by the periphery, which means that participation in globalisation no longer automatically generates the expected gains. More precisely, geographical economy offers an original interpretation of unequal remuneration of production factors (such as wages) between the centre (the location of the market and the suppliers of intermediate goods for production) and the periphery: incomes are higher at the centre than in the periphery because of the distance separating the periphery from the centre. According to Venables (2001), distance is a major source of inequalities. In fact, distance creates costs (search for partners, transportation, quality control/management, time involved in transactions) which are fully borne by the periphery, driving it into a selffulfilling vicious circle. A country in the periphery and therefore far from the centre has to pay the price of its remote location, which makes it even poorer and stops it from achieving the status of centre. According to this reasoning, it is difficult to imagine poor countries from getting out of this situation (the so-called poverty trap). This theory takes a pessimistic view of the reduction of between-country inequalities.
2. Decrease in transportation costs Is the revolution of transportation good news for peripheral areas wanting to break out of this vicious circle? According to Venables, the alleged decrease in costs is no cause for satisfaction for the following reasons. First, the cost of transportation is going down but no faster than the value of goods, which means that distance is actually not less expensive. Secondly, the opportunity cost of time does not decrease for even though distances are covered more rapidly, players must nowadays respond very rapidly to market developments and must therefore be very close to the markets (just-in-time sourcing). Transportation costs remain an issue. Moreover, geographical economy models cast an astonishing light on the impact of cuts in transportation costs: paradoxically, the reduction of transportation costs appears at least initially to spark a concentration of activities. Actually, the development of means of transportation signifies that it is no longer of interest to keep activities dispersed, since dispersion no longer protects them from competition and deprives them of economies of scale. Hence, improvement of transportation benefits the North at the expense of the South, whose industry goes into a decline. We are going to develop this ideas in the next paragraph.
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3. Further analysis of polarisation phenomena Whatever their differences, studies of geographical economics invariably show that an initially symmetric balance between two regions may become asymmetric due to an initial slight imbalance. According to economists, such divergences are due to the process of causality and circular amplification: when a region begins to lose its resources (workers, businesses, etc.), resources begin to build up more and more rapidly in another region, gradually making it more attractive. One of the driving forces behind these dynamics is precisely the decrease in transaction costs (cost of transport, communication, etc.). This is why geographical economics makes a significant contribution to the debate on the consequences of globalisation. Among the traditional models we find the model developed by Krugman and Venables in 1995, which describes the effect of lower transport costs on two initially similar regions. If two regions – North and South – produce two types of agricultural goods and manufactured products (final goods and intermediate goods used to produce final goods) the decrease in transport costs between these regions may undermine industrialisation in the South. Assuming that the North initially produces a slightly larger number of final goods (its manufacturing sector is slightly larger), the demand for intermediate goods (to produce more final products) will be stronger in the North (where profits are higher). The North will start producing a larger variety of intermediate goods, thus reducing the production costs of final goods and prompting businesses specialised in manufactured goods to settle in the North. The industry in the South will shrink while the North will produce even more final goods and so keep the divergence spiral going..... Geographical economics therefore invites a severe judgment of globalisation: - the cost of trade is divided unequally between countries; - lower cost of trade is not necessarily good news for the periphery.
Challenges of specialisation After this general analysis, we are going to focus more specifically on the trade and financial aspects of globalisation. 1. Inequalities of specialisations The unavoidable framework for any reflection about international trade remains the classical theory of comparative advantages25. According to this theory and its many offshoots, it is in the interest of countries to promote trade and to specialise in the goods they produce more efficiently than their trade partners. Here, trade is seen as a game with 25
See appendix 3.
32
a positive outcome, in which it is in the interest of all countries to participate. It is a playing field for complementary skills rather than competition. So it is difficult to conceive trade in terms of inequalities (at least between-country inequalities26). The concept of inequalities fits into the theory of comparative advantages if the following major weakness is recognised: whereas this theory assumes that all specialisations are equal, history shows that not all specialisations are successful. Can we really talk about a comparative advantage when certain countries are limited to the production of goods without spillover effect on their economy while other countries focus on winning markets? Daniel Cohen (1994) notes that Great Britain ordered India to specialise in tropical produce in the first half of the 19th century, obliging it to abandon its infant industry (India was a textile exporter in the early 19th century) and its local crops. Its development was checked by the dismantlement of its industry and repeated periods of famine. However saying that specialisations are not equivalent and do not generate the same wealth in the long term sounds excessively fatalistic; one should not forget that specialisations partly result from political decisions.
2. Endogeneous and exogeneous specialisations According to the theory of comparative advantages, a country cannot choose its specialisation, which is linked to exogenous determinants, such as productivity, factor endowments, etc. By contrast, contemporary theories consider comparative advantages endogenous. For example, policies on labour formation and the accumulation of capital make it possible to modify factorial endowments; innovation strategies permit renewal of comparative advantages; economies of scale permit trade gains, even if there is initially no relative advantage, and so on. In addition to passively enjoyed natural relative advantages, there are therefore acquired advantages: specialisation is not just the outcome of exogenous factors but also of the behaviour of economic agents (public policies, business strategies, etc.) and so becomes an economic policy issue. If this is the case, it makes sense to determine appropriate specialisation criteria.
3. What is a good specialisation? If specialisation is not a given but acquired, what is the right specialisation criterion? - The quality of specialisation can first of all be determined by the degree to which it is adapted to world demand; the right specialisation is specialisation in a sector where demand for goods is increasing. - More generally, specialisation in an industry whose products are viably priced on the international market. Some developing countries have bad comparative advantages since 26
Within-country inequalities can inter alia be explained by the HOS theory.
33
they are specialised in primary products with little value compared with the goods for which these are traded. - A good comparative advantage is also an advantage accompanied by industrialisation and development, e.g. an advantage creating a specialisation in a manufactured product rather than agricultural produce.
The theory of comparative advantages is criticized insofar as it claims that trade benefits all the countries, whereas specialisations are in fact not equivalent Trade is a vector of betweencountry inequalities in that it spreads specialisations irregularly among countries
Financial risks and anticipations
As we have seen, trade liberalisation can have negative long-term consequences, but financial liberalisation can weaken countries in the shorter term. The recent financial crises have shown that financial liberalisation exposes countries to the risk of sudden capital return flows. Many theoretical studies have been devoted to return flows, known as "speculative attacks". ∗ Currency crises theories27 start from the observation that currency controls (implemented to counter inflation or to restore confidence in a currency) may be subjected to two types of speculative attacks. According to the first generation of currency crisis models, exchange rates are abandoned because worsening fundamentals make them unsustainable. For example, when a country creates money to finance a high budgetary deficit, it immediately creates tension between the inflationary pressure generated by the new currency supply and the need to maintain an exchange rate. Currency crises are therefore due to inconsistent economic policy: foreign currency reserves are depleted and sooner or later devaluation is the only option left. Indeed, rather sooner than later, since these models show that speculative attacks are made before the currency becomes worthless: speculators trying to outpace devaluation are prompted to sell assets valued in local currency before they are depreciated. The resulting preventive attack swallows the remaining foreign currency reserves. Second generation models offer a less deterministic view of currency crises. They begin by saying that there is no foreign currency reserves constraint in a world where countries have access to the global capital market. The problem lies mostly in the 27
For a synthesis, see Jeanne (1996).
34
price paid by the central bank to support the exchange rate. The cost of defending the exchange rate (to prevent a capital flight) may be too high, in which case the country may prefer abandoning the exchange rate to paying its cost. For example, a country can always attract capital by raising interest rates but does not always do so since this depresses activity. In these models, the relations between speculators and countries are more complex, since the cost of defending an exchange rate rises when economic agents expect the exchange rate to be abandoned. Their convictions influence the sustainability of the exchange rate. There are several possible equilibriums (when speculators expect the exchange rate to become worthless, the cost of defending the exchange rate rises and the country abandons the exchange rate; if not, the exchange rate is maintained). Certain equilibriums are selffulfilling but this does not mean that fundamentals are no longer relevant to crisis analysis. Economic agents start anticipating devaluation of a currency because of weak fundamentals, which means that even self-fulfilling speculation is tied to fundamentals. In other words, deterioration of fundamentals increases a country's vulnerability to crises but does not mechanically trigger a crisis. To sum up, assuming the existence of a series of fundamentals necessarily resulting in a crisis and a series of fundamentals never leading to a crisis, second generation models state that there can be a series of intermediate values where anticipation determines whether or not a crisis will occur. ∗ This last point deserves special attention: liberalisation not only makes countries vulnerable because it exposes them to international sanction in the case of bad performance (fundamentals-led approach) but also because it subjects them to the reversing of expectations, some of which are self-fulfilling. This dependence on opinion is one of the most worrisome aspects of financial liberalisation. It does not just concern the developing countries but also the rich countries (as witness the crisis of the European exchange rate mechanism in 1992-1993). A case in point is the analysis made by Paul Krugman (1999) of the contagion during the Asian crisis. The fact that investors suddenly withdrew their capital from Asian countries with still sound fundamentals (such as Indonesia) was partly due to a mistaken understanding of the area. Their interest had been fuelled by a belief in an "Asian miracle" and when the economy of one country (Thailand) turned out to be less than "miraculous", investors not only lost confidence in this country but in the entire Southeast Asian zone. So they withdrew their capital, worsening the situation of the strongest economies and providing good ex-post reason for pulling out. "It didn't matter that these economies had very few trade links. Investors believed that they were linked and that the difficulties of one Asian economy meant bad news for the neighbouring economies; and when an economy is predisposed to self-perpetuating panic, the mere belief in panic sparks panic".
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Thus, financial liberalisation exposes countries to the danger of reversing market anticipations. Such reversals are sometimes justified and sometimes mistaken on an ex-ante basis (although justified on an ex-post basis, since they are self-fulfilling). ∗ In conclusion, liberalisation can weaken economies by: - generating polarisation, strengthening one region at the expense of another; - pushing countries to specialise in unprofitable sectors; - exposing countries to the risk of self-fulfilling financial panic.
What kind of liberalisation for the developing countries? It has been argued again and again that trade with Third World countries must be liberalised in order to pull them out of underdevelopment and it is true that liberalisation provides the means to get out of underdevelopment. The performance of autarkic countries has remained far below that of NICs with extravert strategies. Hence, globalisation means salvation… But we should not conclude that liberalisation is automatically accompanied by gains: - first, liberalisation is not enough to achieve convergence. Liberalisation is only one prerequisite, which provides "opportunities" (with all the virtuality implied by this term). - secondly, liberalisation comes at a cost (restructuring of the production system according to the comparative advantages, distance, weakening of the financial system etc.). In other words, globalisation is the playing field of a high-risk game. It is possible to win a lot (which is why the "globalisers" are the most successful countries) and to lose a lot (e.g. due to the shock triggered by unfavourable terms of trade or to the stranglehold of a strong dollar on highly indebted developing countries). Thus, the relevant question is not so much whether or not to open up the country but what kind of liberalisation is necessary to minimise risks and costs while taking advantage of opportunities? How to gain from globalisation?
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Robust liberalisation Globalisation is a process of transfers (of goods, human beings and technologies with the FDIs, etc.), which create an equal number of new opportunities for the countries that have opened themselves up to trade. Such transfers will only be successful if the poor countries can actually appropriate these new elements (e.g. new knowledge in the case of FDIs). Underdevelopment traps (the development level below which participation in globalisation does not benefit an economy but only generates costs) are the zero absorption point. A strong institutional framework is essential to make absorption of transfers easier, as shown by the comparison between the Chinese and the Russian ways. This means that countries must have a strong State which controls the liberalisation process and is accompanied by institutional reforms and appropriate internal policies, reflected in the implementation of a strong, regulated financial system, good macroeconomic management, oversight of the way foreign capital is appropriated (one remembers the bad debts left by the Asian crisis), etc. As national economies are especially weakened by one dimension of globalisation – capital movements – the protection of host countries against sudden capital return flows must become a priority. This requires identification of factors, making the economy vulnerable to capital movements (e.g. debts in foreign currencies).28 Note: This brings us to the issue of "good governance"29. This issue should not make us overlook a more traditional concern, i.e. the problem of "capacities": rules are no cure-all when countries do not have the necessary capacity in terms of infrastructures, institutions, human capital, etc. Good regulation without good capacities makes it impossible to sustain liberalisation.
Diversified liberalisation The developing countries must: -
diversify their exports to reduce their exposure to changes in the terms of interindustry trade. choose winning specialisations (manufactured products).
These two points are well known and no longer debated. By contrast, analysts have focused their attention in recent years on new technologies; in this sense, diversification of liberalisation may appear to be a problem. 28
See Appendix 2. The term governance refers to the rules used to regulate society and to the corresponding inspection procedures. This term is preferred to government, which implies public-sector regulation, whereas good governance includes general rules for the private sector.
29
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Note: Information and communication technologies30 The rapid progress of information and communication technologies may be an opportunity for the developing countries. Are these technologies vectors of more egalitarian globalisation?
The ICTs seem to be a means to accelerate development in different ways: -
the argument used most frequently to promote ICTs is not the most convincing. It is often said that the technical progress resulting from ICTs generates high productivity gains and so favours job creation and wage hikes. However, this Schumpeterian approach is double edged: while the ICTs create wealth (by spreading innovations), they also destroy whole sections of the old economy (known as "creative destruction").
-
it is also argued that ICTs permit savings on costly infrastructures (organisation of an online education system bypassing the need to build schools; online sales creating a genuine national market with a thin distribution network, etc.). But this argument is not very convincing either (see below).
What we can expect from the ICTs is a smaller contribution to development:
30
-
better training and enrichment of the human capital: the internet facilitates access to know-how and training.
-
better access to information. The ICTs promote transparency of information. This makes it possible to solve certain problems with asymmetric information which hamper the development of the developing countries (e.g. by increasing banking risks). This may also give the authorities the opportunity to improve their knowledge of relevant problems and possible solutions, which would improve government.
-
better specialisation. The developing countries can specialise in the ICTs, which offers two advantages: the initial investments are lower than in other activities and the growth rates are higher.
-
a more attractive environment. The organisation of communication infrastructures is a sine qua non to attract foreign capital and major foreign corporations (since their systems are based on just-in-time sourcing).
-
better integration (more direct) in world trade: better knowledge of global demand and higher prices for local resources make it possible to reduce the weight of
For further information, see Thierry Vedel (2002).
38
intermediaries and their negative impact on the margin (contact is more direct between producers and consumers).
However, the ICTs may turn out to be double edged: -
growing use of the ICTs does not mean that infrastructures are no longer needed. For example, the physical circulation of products continues to account for a significant portion of economic activity, even with ICTs, which means transportation.
-
the new technologies are only effective if they are combined with organisational changes, as shown by Philippe Askenazy (CAE report 2000): IT often remains a costly gadget if there is no suitable production organisation. But the developing countries do not always have the necessary administrative system, ICT support policies and organisational adjustments.
-
The ICTs could be considered a means to preserve the global imbalance between rich and poor countries, similar to the reasoning adopted by advocates of economic geography, which looks askance at lower transportation costs since the resulting gains do not benefit all countries equally.
To sum up, we will not count too much on new technologies to accelerate development.
Careful liberalisation
"A protected market can encourage rather than discourage exports and perhaps even raise national income" (Krugman 1996). In certain cases, a temporary protection of the national markets may turn out to be effective. Economists agree that complete trade liberalisation is generally a good thing bar a few exceptions: -
-
In an environment with increasing returns and imperfect competition, a country needs to make sure that additional profits on a lucrative market go to the national enterprise. More exactly, if increasing returns come from the experience gleaned from a long period of production (the "learning curve"), the producer has to take a larger market share than its competitors when launching a product, since it will have a cumulative and irretrievable competitiveness advantage. It is therefore essential to establish an initial advantage, which may justify temporary protection of the market or subsidies; The country must also encourage and protect activities producing externalities; More generally, as we have seen, a comparative advantage is not (only) a given: it may be acquired. It may therefore be judicious to remain closed for the time 39
necessary to accumulate experience (learning by doing) in order to be competitive at the moment of liberalisation. If not, hasty liberalisation puts national businesses in competition with businesses from countries with low production costs producing the same goods at lower prices. Protectionism may therefore be a good temporary strategy prior to liberalisation (List's old thesis). Thus, the problem of trade policy is not to decide whether or not to open up the country but when. It may be in China's interest to import inexpensive mobile phones for a period of 10 years, during which this item will benefit other Chinese sectors, and to start manufacturing mobile phones after 10 years once it has built up enough experience to make them at low cost. In other words, timing is the relevant issue, whereas analysis of comparative advantages is purely static.
Financial liberalisation should be tackled more cautiously. Hasty liberalisation can make a country extremely vulnerable, as witness the Asian crisis (lack of market maturity, leading to moral hazard): the Asian crisis has shown that it is necessary to well sequence financial liberalisation, permitting postponement of each phase as long as the country does not have sound structures, including a system of prudential oversight. Liberalisation needs to be gradual since it needs to be strong. ∗ Today, the debate focuses on the difference in pace between trade and financial liberalisation. We have seen that trade liberalisation needs to be forwarded with determination while financial globalisation needs to be pursued more cautiously. Liberalisation is not an indissociable whole. On the other hand, financial and trade liberalisation are not entirely independent: - trade liberalisation needs to be followed by financial liberalisation or it will starve due to reduced export capacity; - conversely, financial liberalisation without trade liberalisation exposes a country to the risk of a self-fulfilling financial crisis when speculators start considering the currency debt/export ratio unsustainable31.
31
A good example is Argentina, which, from the beginning of the nineties to the currency crisis in December 2001 had a currency board. At the time, the Argentineans had dollar-denominated debts to Argentine banks and the international financial institutions while carrying on business in pesos. For creditors, repayment depended therefore on the existence of a currency board (which maintained an exchange rate of 1 peso for 1 dollar). If the creditor expected the currency board to last, 1 dollar would equal 1 peso and as public debt (dollar denominated) came to only 50% of GDP (in pesos), Argentina would not seem to suffer from debt overhang. But if the creditor did not believe that the currency board would survive, he would want Argentina to repay its loans with foreign dollars. In other words, to assess the sustainability of the debt, it had to be compared
40
We should therefore advocate liberalisation instead of a "free trade" policy since the term liberalisation stresses the idea of an ongoing process. Liberalisation becomes necessary when sectors can be exposed to international trade. However, it is also necessary to make sure that the liberalisation timetable does not promote economic rents.
Reciprocal liberalisation Countries must have an equal degree of liberalisation to prevent the liberalisation of the developing countries from weakening them. -
-
First of all, the industrialised countries require the developing countries to liberalise their trade while they themselves continue to protect whole sections of their economies from international competition (such as agriculture). Moreover, while migrations made a major contribution to the convergence of countries in the 19th century, the rich countries are nowadays more or less closed to migration from the poor countries.
So there remain major obstacles to the penetration of migration and trade flows of the developing countries in the rich countries. This said, it should be acknowledged that Europe is ahead of other industrialised countries (The "Everything But Arms" agreement liberalises the European markets by removing customs duties for all products save arms from the 48 LLDCs). Note: Not all protection measures penalise the developing countries to the same extent. The agreement on agriculture signed in Marrakesh in 2001 distinguishes between distortive subsidies (which includes export subsidies) and other types of subsidies that are less damaging to trade: - general services as research, training and promotion. - direct, support for producers (subsidies not based on production but on the farmer's condition).
with exports (capacity to obtain "real" dollars) instead of GDP. The creditor making this calculation would discover that the debt amounted to 500% of export sales, which was wholly unsustainable. This, in the middle of the nineties, credit interest rates began to reflect a very high risk premium. This made debt unsustainable and the Argentineans insolvent, precipitating the currency crisis. This kind of crisis is self-fulfilling. If you do not expect the currency board to last, the debt (compared with exports) is enormous, which explains a sharp increase in interest rates, thus making the debt factually unsustainable.
41
Supported liberalisation The trade liberalisation policy must be accompanied by policies conducted by the industrialised countries.
1. Why give aid? There is a widespread belief that aid is pointless. This is frequently backed with the following two arguments: "trade not aid" and nationalism. Argument 1: public aid or private capital? The slogan "trade not aid" is an invitation to reduce ODA in favour of private finance. The liberals believe that international private investment alone is effective. This position is nevertheless open to criticism. By themselves, market mechanisms appear unable to help countries get out of underdevelopment. Aid and trade are complementary instead of exclusive. In fact: -
-
-
the allocation and volume of private capital do not take account of the fact that certain projects can generate externalities (positive or negative), resulting in insufficient finance; private funding is not efficient for projects with the status of public goods since the beneficiaries can behave as free riders; moreover, private capital is allocated highly selectively (discrimination against Africa) and extremely volatile, which is not always consistent with long-term development aims; lastly, private capital is invested for profit, which does not necessarily push qualitative development (well-being) or social justice.
Argument 2: purely altruistic aid? Another oft-heard criticism of ODA is backed by nationalistic arguments (aid is a waste of money at a time when the budget can be used more profitably for domestic problems). This overlooks the fact that the industrialised countries benefit from the returns generated by the assistance granted to the developing countries. Economists have long shown that there is a relative lack of interest for inequalities. In North-South relations, development economists have given priority to growth, development and reduction of poverty and considered inequalities a secondary problem. The neoclassical school considered inequality at worst a necessary evil and at best a growth accelerator by concentrating savings and investment capacities in a few hands and 42
providing an incentive to work and innovate. In recent years, economists have begun to focus on inequalities: the fight against inequalities is on the agenda for efficacy reasons. We no longer fight inequalities only in the name of equity but also in the name of efficacy. According to Sachs (2001), it is in the interest of the rich countries to help the developing countries get out of underdevelopment, since the economic success of poor countries increases the well-being of rich countries. For example, a worsened economic environment may weaken the government or trigger an overthrow, which would jeopardise foreign interests. But Sachs goes one step further, mentioning a whole series of cases in which the rich countries are suffering the repercussions of the problems encountered by poor countries: threats for national security (terrorism), drug traffic, environmental damage, propagation of diseases and so on. Sachs ends his article by urging the rich countries to support development more actively in their own interest.
2. Origins of failure of aid Analysts agree that development aid is effective in some cases and ineffective in others. This means that aid can potentially stimulate development but is sometimes a waste. This raises the question what conditions determine whether ODA is effective32. 1 It has been observed that development and the alleviation of poverty occur when the developing countries choose "good policies" (policies designed to promote development33). Aid is effective when accompanied by adequate reforms. By contrast, in countries that do not choose good policies aid will merely delay reform and help finance bad policies. 2 It has been observed that the most effective reforms have been appropriated by government and civil society. In other words, the success of reforms or projects financed with foreign aid depends on commitment by the beneficiaries. If the beneficiaries do not support the aid actively (if reform is imposed from outside), the beneficiaries tend to remain aloof and reject responsibility for the funded activities, which leads to failure. 3 The third problem is the fungibility of aid. Aid allocated to a given sector or project often makes it possible to free up resources the government would otherwise have earmarked for the sector or project concerned. Thus aid allows countries to increase spending in sectors lenders do not want to finance (such as the purchase of arms).
32
These analyses are based on several articles about the effectiveness of ODA, i.e. the last two chapters of the World Bank Report on Global Development 2000/2001; the World Bank Report, "Aid and Reform in Africa: Lessons from Ten Case Studies", 2001, and the press conference held by David Dollar and Alan Gelb on this topic; the World Bank Report, "Assessing Aid: What Works, What Doesn’t and Why", 1998. 33 The expression "good policy" is discussed below.
43
4 Aid can also fail not because it is misused but because its amount is too low. The NGOs regularly point out that the industrialised countries have many times agreed at UN level to earmark 0.7% of GDP to ODA. However, ODA has steadily declined since 1992 (in real terms).
3. Proposals
Proposal 1: financial aid versus assistance Once it is agreed that aid is effective to the degree that the beneficiary conducts good policies, ODA would be effective if it would prompt countries to pursue such policies. But here is the problem: all case studies agree that financial aid is generally unable to stimulate good domestic reforms. The report on Aid and Reform in Africa states clearly that "there is no consistent relationship between aid and reform". We must therefore decide to allocate financial aid selectively by giving financial aid to countries with good policy choices. According to Dollar, aid is currently allocated far from optimally since the funds are funnelled mostly to countries with bad policy choices. This does not mean that we should not help countries whose political and institutional frameworks are unfavourable for development. It merely means that they should not be given financial aid (since the money will not be used for reforms but to forward bad policies and corrupt practices and justify delaying genuine reforms…) but that aid for countries with bad policy choices should mostly take the form of support for institutions and expert assessment of good policy choices. More exactly, aid needs to be adjusted over time. Initially, when a country does not make serious reforms, aid should be limited to technical assistance, humanitarian assistance and policy advice. These make it possible to consolidate the institutional and political framework and promote the emergence of good governance. In other words, it is necessary to provide assistance instead of distributing funds that do not lead to reforms. Financial should subsequently increase to the degree that policies improve.
Proposal 2: appropriate aid versus conditional aid The most effective reforms are those appropriated by the countries concerned, not reforms imposed from outside. This runs counter to the traditional approach to ODA, which ties aid to conditions designed to ensure they are used appropriately. After the debt crisis of 1982, the IMF and the World Bank subjected facilities and debt rescheduling to the adoption of structural adjustment lending programmes with sometimes very precise conditions. The failure of these programmes shows that conditionalities do not replace commitment by the population. This has the following corollaries:
44
-
it has become clear that conditionalities have been overused. Thus, it is necessary to reduce the conditions, i.e. to discontinue loans with 50 or 60 conditions;
-
it is necessary to implement mechanisms to consult and dialogue with civil society and the political establishment. It is essential to involve representatives from civil society, i.e. the NGOs and members of parliament. More generally, it is necessary to take the local situation more accurately into account;
-
it is necessary to favour general aid (sectoral aid, budgetary aid or debt relief) over aid that is targeted (projects). This is the view of the sectoral approach that has emerged in recent years, according to which the beneficiary country needs to develop a strategy for a given sector and lenders agree to support the entire sector rather than particular projects (the activities carried on in this sector are executed by the beneficiary country). More generally, this sectoral approach can be applied at the scale of an entire country by advocating budgetary support for governments with good development strategies.
The initiative taken in 1999 by the World Bank and the IMF to fight poverty illustrates this new type of aid: countries interested in financial aid from either organisation or debt relief within the framework of the HIPC initiative need to submit a programme to fight poverty and pursue a suitable three-year strategy. This process is based on participation of both lenders and social players in the development and follow-up of the implemented policies.
Proposal 3: direct aid versus indirect aid As aid is fungible and as its success depends on the quality of the institutional framework, the proportion of aid earmarked for institutional reforms and political advice should be increased at the expense of project aid. Aid is sometimes more productive when used to lay the institutional foundations for an effective fight against poverty by promoting the emergence of good governance. Thus, effective aid has an indirect effect on poverty rather than a direct effect (as with projects).
Proposal 4: loans versus grants In the wake of the Meltzer report, it has been regularly proposed to convert loans into grants and to provide future aid in this second form. In support of this proposal, there are many arguments in favour of grants: -
it is time to start focusing on transparency and to acknowledge the insolvency of certain developing countries. It is necessary to stop granting the developing countries so-called loans they can never repay. 45
-
ODA is used to invest in human capital (schools, health), which does not generate a direct profit and therefore cannot be covered by actual loans. lastly, the developing countries are suffering from serious savings deficits (not enough domestic savings for the necessary investment). This shortfall cannot be absorbed merely by raising the domestic savings rate (which would harm consumption). This calls for inflows of foreign resources, whose volume is such that they cannot only take the form of debts.
On the other hand, conversion of loans into grants exposes the beneficiary countries to the risk that: - access to the global capital markets will be closed (investor distrust), even if historically no such conduct has been observed after debt forgiveness. - the total amount of aid diminishes due to the reduction of the lending capacities of the donors. More generally, it can be seen that the problem is not so much the loans themselves as the policies of the beneficiaries countries, which do not generate enough growth for debt service. When loans are granted to countries with bad policy choices, they do not grow enough to generate the wealth necessary for repayment. By contrast, loans do not raise problems when granted to countries with good policy choices, since these are able to repay them.
Proposal 5 The recent initiatives of the industrialised countries should be acknowledged for the amount of ODA involved. The EU Member States plan to raise their average ODA to 0.39% by 2006 (countries whose ODA is less than 0.33% of GDP have agreed to top this percentage out to 2006). France, the largest G7 donor (as a % of GDP) plans to raise its assistance to 0.36% in 2002.
Conclusion These proposals call for more careful selection of beneficiary countries and instruments. This said, certain points remain problematic: -
the definition of good governance needs to be put on the agenda. While it is undoubtedly better to lend to developing countries with good policy choices, it remains necessary to clarify the meaning of "good policy choices". According to the report "Aid and Reform in Africa", good policy choices combine low inflation and trade liberalisation, with robust financial markets, effective laws, availability of basic services, etc. It may well be asked whether this does not conceal structural adjustment policies based on the three pillars of macroeconomic 46
stabilisation, external liberalisation and internal liberalisation - policies which had ambiguous results; -
the World Bank and the IMF tend to assume that development results are entirely caused by the policies conducted by the beneficiaries of aid, which is tantamount to ignoring the existence of other reasons for failure of aid (protection of intellectual property rights, armed conflicts, financial globalisation, global economic crisis, etc.).
Conclusion The foregoing reflections on liberalisation methods may suggest that a well-conducted liberalisation strategy is the only solution and a universal means of solving development problems. However, several reasons militate against reviving the liberalisation cult. 1 The solution to these problems cannot be expected to come entirely from outside and development, at least in densely populated countries, requires the creation of a large domestic market. In an analysis released in 1980, Lewis took this view wholeheartedly. According to him, the domestic market rather than exports should be the engine of growth since outward development strategies make the developing countries excessively dependent on the liberalisation and the growth of the rich countries. 2 The full gains from liberalisation are probably only available above a certain minimum level of aggregate development and wealth34. Classification of liberalised countries by income level shows that while the most liberalised countries enjoyed the highest growth rates in the 1990s, low-income countries took less advantage of liberalisation than middle-income countries. The poorest countries are seriously handicapped by such exogenous factors as geographical isolation, narrow domestic markets, lack of production factors and the burden of history (colonisation). All these elements form an "initial state" preventing such countries from taking advantage of liberalisation. In this case, a trade liberalisation policy is not a priority. It is first necessary to improve the initial conditions. While these observations should not prompt a fatalistic and pessimistic judgment of the situation in the poorest countries (i.e. that it is impossible to catch up below a certain poverty threshold), they suggest that: -
34
liberalisation is one of the ingredients of catching up but should not be expected to do the whole job. for the poorest countries, liberalisation is not always the right and prior solution.
See the CEPII letter of October 2001.
47
Chapter 4 Globalisation developing countries
and
inequalities
within
We will now take a look at the effect of liberalisation on the distribution of income in the developing countries. We want to isolate the effect of globalisation on the poor populations. This is not easy given the many factors that can aggravate the situation of economic agents in the developing countries.
The losers in the globalisation process Who are the losers in the globalisation process in the developing countries?
1. The poor The NGOs believe that globalisation does not just have a non-egalitarian impact between countries but also within countries and that it worsens the situation of the poor in the developing countries. The World Bank has changed its position in this respect. While it still maintains that liberalisation of trade and of the developing countries promotes convergence between countries (by reducing between-country inequalities), it has made the fight against poverty a priority ("pro-poor" growth), acknowledging that globalisation can have negative distributive effects. There is an emerging consensus that the poor populations in the developing countries can be the losers in the globalisation process. Note: poverty is not only defined in the light of monetary criteria (not enough income to buy essentials). It takes new forms in the context of globalisation: - it has the characteristics of a trap, i.e. a situation in which mobility is low and in which it is less easy to take advantage of trade gains. The poor populations can be said to be "immobile". - it also shows itself in vulnerability and greater exposure to the negative shocks triggered by globalisation. Poverty can be associated with loss of job security.
2. The peripheral regions Inequalities are also regional in the developing countries (gaps between cities and countryside, seaboard and the interior, etc.). As the Chinese example shows, cities and export hubs are the first to benefit from international liberalisation. 48
The symbol of those whose lose out in globalisation is therefore the poor peasant living in the country far from the coast.
Evolution of poverty
The above graph shows that the number of people in the world (in millions) with less than a dollar a day increased significantly before application of the development process to dense populated countries reduced the number of poor people. This trend turned around in the fifties. ∗ How has poverty35 evolved during the last ten years - the globalisation decade? The following three observations show contrasting results: -
whereas the world population continued to increase by 70 million people p.a., the number of people in dire poverty remained stable in the 90s; its proportion decreased from 29% in the beginning of the 90s to 24% at the end of the decade;
-
Sub-Saharan Africa houses 290 million people in dire poverty, but many of them are surviving far below the poverty line. This could explain why it is so difficult to eradicate poverty in these countries: pro-poor growth cannot have a strong impact on poverty in the short term since it must first raise the poor above the poverty line of US$ 136;
35
The poverty line is measured at USD 1 a day.
36
Chen and Ravallion (2000).
49
-
lastly, the Asian crisis has clearly had a major impact on poverty. According to several studies, the number of poor people in the developing countries would have decreased after 1993 if the Asian crisis had not occurred.
The results are therefore neither disastrous nor really encouraging. Moreover, the third argument is ambiguous, since the Asian crisis was largely due to globalisation.
Responsibility for globalisation We shall now try to determine whether or not trade aggregates inequalities in the developing countries. Theoretical approaches The general framework for our analysis remains the theory of comparative advantages. However, we will use its factorial version (HOS theory), which offers interesting predictions about the effect of trade on within-country inequalities. A specific benchmark for internal inequalities in the developing countries is Kuznets' theory, which examines their evolution as countries develop.
1. Liberalisation and inequalities
The great theoretical benchmark for the effect of trade on the distribution of income in any country is the Heckscher Ohlin Samuelson theory37, which can be applied to the developing countries. This theory applies to a world with two factors and two countries. Let us assume that the factors are skilled and unskilled labour and the two countries the North, which has abundant skilled labour, and the South, which has abundant unskilled labour. According to theory, trade would raise the remuneration for skilled labour and lower the wages for unskilled labour in the North, whereas the reverse would take place in the South. As skilled labour is the preserve of the wealthy populations and as many poor people are unskilled workers, the situation of the rich improves in the North and deteriorates in the South, and vice-versa for the poor. According to this theory, trade should reduce inequalities in the South.
37
See Appendix 2.
50
According to O'Rourke, the globalisation process of the last few decades shows that the predictions of the HOS model are not borne out in practice. While theory is confirmed by the development of the South-East Asian countries in the 60s and 70s, the liberalisation of the 80s appears to have worsened inequalities in Latin America. Moreover, econometric studies show that differences in income decreased in the high-income countries in the 80s and 90s but apparently increased in the middle-income countries (such as the former Soviet satellites). China provides an excellent example of a country where inequalities have increased during the last decade. These trends nevertheless do not contradict this theory by themselves, since income distribution is the result of many factors. Trade (and globalisation) is not the only component influencing the demand for production factors and therefore income. Technological developments, weakening bargaining powers for the unions, the fall of communism, education and demographics all help determine changes in inequalities.
2. Growth and inequalities Although the HOS theory is a benchmark tool for analysing within-country inequalities, it does not specifically factor in inequalities in the developing countries. Kuznets' theory focuses on the case of the developing countries but ties inequalities to growth instead of trade. Kuznets (1955) endeavours to clarify the relations between growth and inequalities. According to him, growth initially worsens and subsequently reduces inequalities. At first, businesses profit from an unlimited pool of labour in obsolete sectors affected by massive unemployment. This source dries up gradually, wages increase and labour starts to generate social costs (social protection, safety measures, etc.). The State shaves the highest incomes and subsidises the lowest. All this generates intensive consumptiondriven growth, led by middle-class employees. This model was confirmed by recent developments in the NICs, which shifted must faster to the second stage, explaining their spectacular growth (early fordism). Kuznets' argument is therefore that labour migrates from low-productivity sectors to high-productivity sectors as part of the structural changes accompanying development.
Conclusion The above two theoretical arguments do not contradict each other but reflect two facets of the same process, which could be called "creative destruction" in Schumpeter's phrase. Prior to liberalisation, countries specialise in the production of goods with a comparative advantage. This frequently leads to the destruction of whole sections of the old economy and their replacement by industries requiring unskilled labour (market gardening, consumer electronics, garments, etc.). The rural exodus triggers the emergence of an
51
urban working class looking for jobs in new sectors. Kuznets's thesis clearly explains the downside pressure on wages accompanying this change in production. On the other hand, this change creates an export economy buoyed by strong demand from foreign countries. The HOS theorem shows the consequences of fresh integration in international trade. Theoretically, it is therefore possible to isolate two opposing forces at work during reallocation of resources: - on the one hand, trade tends to reduce inequalities in the developing countries due to their specialisation in goods requiring unskilled labour on the back of growing global demand. - on the other, the presence of an enormous labour pool builds up strong downside pressure on wages.
Empirical studies provide the best way to determine the net result of creative destruction.
Empirical studies
1. Effects of liberalisation on income Dollar (2001) compares the development of inequalities within two groups of countries (post-80 globalisers and non-globalisers) and draws the following conclusions: -
the total number of poor people has increased in the non-globalisers and decreased in the post-80 globalisers (inflation has dropped significantly in the post-80 globalisers, which benefits the poor);
-
the poor benefit from globalisation since increased trade goes hand in hand with acceleration of growth and does not change the distribution of incomes (the losers and the winners are evenly distributed across the income scale; inequalities do not diminish but do not increase either), i.e. as everyone profits equitably from liberalisation gains, liberalisation raises the rate at which the income of the poor improves.
-
as liberalisation accelerates growth of the income of the poor and the rich in equal measure, poverty may diminish but not inequalities.
According to Dollar, globalisation therefore does not affect within-country inequalities and so benefits the poor.
52
However this is an aggregate result based on a variety of national experiences. In reality, some countries decide to share their globalisation gains while others do not. Thus, the degree of internal inequalities also reflects national policy choices and preferences. Most countries appear to have the means necessary for fair redistribution of wealth but not all do so. In other words, inequality is primarily caused by bad distribution of trade gains, inter alia due to policy choices.
2. Other effects of liberalisation Globalisation cannot be reduced to trade liberalisation. Various phenomena connected with globalisation increase the vulnerability of the poor populations (this refers to the general idea that globalisation has an adjustment cost not borne by all). The weakening of certain populations can take several forms: 1 Certain economic phenomena are manifestations of globalisation and have a direct impact on the poor populations: -
disruptions of the pricing system, such as worsening terms of trade or inflation are extremely harmful for the poor; competition between developing countries also affects poverty. In the 80s, liberalisation in Latin America coincided with a growing gap between wages for skilled and unskilled labour, since the Latin-American countries were liberalising at the same time as poorer countries such as China and India.
2 But globalisation also has an indirect impact on inequalities within the developing countries through the austerity policies such countries must implement to remain attractive and competitive in a more open environment. This is visible in financial crises, generally followed by austerity policies that are very damaging for the poor (since they affect income, employment and social spending as part of the fight against the budgetary deficit). The number of people living on less than US$ 1 a day in East Asia and the Pacific fell from 417 million in 1987 to 265 million in 1996 before rebounding to 278 million in 1998 during the Asian crisis38.
It is difficult to measure the actual impact of globalisation on internal inequalities, since, even if liberalisation does not have a direct effect on inequalities (Dollar's hypothesis), globalisation manifests itself indirectly during economic shocks with negative consequences for the poor populations.
Reducing inequalities
38
World Bank (2000).
53
The question of objectives A clearly identified objective is essential when assisting poor populations. It has long been custom to fix a growth objective, which would automatically alleviate poverty. Poverty was therefore fought indirectly by means of growth policies. This is a relatively legitimate position since growth reduces poverty. The empirical link between growth and the reduction of poverty can be illustrated by the many textbook examples afforded by India, China, Vietnam, etc. More generally, their link is demonstrated by drawing a comparison between Asia and Africa: strong growth in Southeast Asia and the Pacific explains why poverty dropped from 28% in 199039 to 15% in 1998, compared with 48% and 46%, respectively for Sub-Saharan Africa40. Today, development players prefer more direct policies41 for poor populations. The problem is whether it is possible to tackle the whole issue of income distribution (fight against inequalities) or only poor populations (fight against poverty). This needs to be determined case by case.
Why should within-country inequalities be reduced? The reduction of within-country inequalities is a sine qua non to get out of underdevelopment. Too much internal inequality hampers growth in the following ways: -
although certain countries open to international trade base their development on extraverted strategies, it is not in their interest to neglect growth of the domestic market, which has to take over from external demand once a certain level of development is reached42. Hence the need to reduce internal inequalities;
-
high inequality can result in high public transfers, financed by distortive taxation, which can lower economic efficiency;
-
high inequality makes it impossible for the poorest to access credit and insurance and to deploy their production potential (so-called "traps" occur when the capital and insurance markets are imperfect) and takes away the incentive for the wealthiest (who have become mere rentiers) to do so;
-
lastly, the aggregation of inequalities promotes corruption and criminality.
39
In 1990, 28% of the population in this area was still living on less than 1 dollar a day. World Bank (2001b). 41 In addition to growth. 42 According to Kuznets, the emergence of a type of fordism speeds up development. 40
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In other words, growth requires reduction of internal inequalities. It can be observed empirically that the most successful developing countries are those that have made both quantitative and qualitative efforts to reduce inequalities (health, education, etc.)43.
Instruments to fight inequalities
1. The problem There is no universal formula to solve the problem of poverty. We will here try to outline the general problem, but individual priorities will have to be set case by case according to local institutional and social resources and characteristics. The current approach to internal inequalities is heavily influenced by Sen's analysis of inequalities and therefore gives priority to the fight against inequality of opportunity (relegating the fight against de-facto inequalities to the background). According to this view, the problem must be tackled at the root: we must not fight poverty and inequalities on an ex-post basis (passive redistribution) but prevent them from becoming traps on an ex-ante basis. Once inequality of opportunity has been corrected, it is not desirable to reduce the remaining inequalities since they are due to merit. Policies to fight inequalities must therefore promote the integration of the poor classes: - integration in economic life: access to the capital and insurance markets, entrepreneurial possibilities, etc.; - integration in political life: the right to expression and representation, etc.; - integration in society: eradication of extreme poverty and exclusion and measures to foster social mobility. However, increased opportunity is not enough to solve the problem of inequalities, since the definition of poverty does not only factor in the existence of obstacles to mobility but also vulnerability and exposure to risk. The fight against unequal opportunity should not make us overlook de-facto inequalities, not all of which can be reduced to inequalities of merit. Integration measures should therefore be supplemented by protection measures for the most fragile populations. This means that a purely liberal approach (redistributing once and for all and guaranteeing mobility) is not enough.
2. Integration measures According to new theories on inequalities (Amartya Sen), the main problem with poverty lies in the existence of barriers reducing the mobility of the poor populations and their integration in economic, political and social life. 43
For more details, see the DIAL report on the poverty reduction strategies in 2001.
55
The fight against inequality of opportunity is therefore a priority. It is necessary to provide new opportunities for the poor in order to prevent poverty from becoming a trap. This makes it necessary to identify the factors preventing the poor from getting out of their condition and keeping them destitute from generation to generation.
a. Socio-professional integration Economic integration requires a closer focus on the assets of agents and easier social integration. 1 Promoting human and physical capital - As regards human capital, an easier access to labour market the labour market requires to develop education (programmes to keep students at school) and health (vaccination, nutrition). - As regards physical capital, people must have the possibility to invest (credit) and to produce marketable quality goods, which requires access to raw materials (water), reliable electricity services, transportation, etc. 2 Ease of access to the market - The first requisite is to remove the social barriers (distinctions based on sex, ethnic groups and social status) paralysing the developing countries. This requires stronger democratic institutions and the elimination of privileges (legislative and legal provisions penalising individuals for reasons connected with race, sex, etc.) and may require positive discrimination. - The second requisite is to develop markets and means of transportation allowing the poor to sell their products.
b. Political integration When speaking about opportunities and integration, we do not just mean economic integration in the labour market. We also refer to political participation (i.e. the right to expression and representation). In this area, it is necessary to promote dialogue with civil society (democratic consultation) and to provide better access to the political sphere, which requires the removal of certain institutional barriers. Note: the economic and political dimensions of integration are linked; better political integration of the poor allows them to demand measures addressed more specifically to their needs, in turn promoting their economic integration: only organisations of the poor can bring the pressure necessary to make sure government decisions meet the needs of the poor. These can also curb corruption and arbitrary actions on the part of the authorities and it will also help improve integration.
56
Nevertheless, the fight against inequality of opportunity is not enough in itself. High social mobility can make the poor classes more vulnerable to economic and social evolutions. There is no guarantee that the greatest social fluidity reduces the risks besetting economic agents and their vulnerability to these risks.
3. Protection measures The poor populations should be offered a certain security, guaranteed by two types of measures: -
the vulnerability of the poor populations to various risks, such as economic shocks, bad health (diseases), climatic disasters, physical violence, etc., must first of all be reduced. This requires the development of insurance mechanisms, enhancement of the assets of the poor (since for example highly skilled labour is less vulnerable) and greater responsibility on the part of the government, which must take the measures necessary to manage the risk of general shocks (for instance, stimulating private investment requires a stable monetary policy and transparent business law);
-
in the longer term, measures should be designed to reduce the risks themselves (or at least exposure of the poorest populations to these risks), such as civil conflicts, AIDS, natural disasters, etc.
4. International assistance To sum up, poverty is eradicated by boosting the number of opportunities for the poor populations and reducing the risks to which they are exposed. The developed countries and the multilateral organisations must accompany these measures. In fact, many of the forces determining the existence of the poor are not under their control. The developing countries cannot ensure international financial stability, achieve progress in medical research or promote trade liberalisation in the industrialised countries. In other words, the poor are directly affected by factors outside the national framework and not under their control, such as trade, capital movements, technological progress, diseases, conflicts, etc. Thus, global action complements national measures in the following areas: environmental damage; human rights (the poor must be given the right to take part in discussions and to express themselves in global forums); armament sales; the occurrence of crises, especially financial crises; global public goods -goods whose use cannot be made conditional upon contribution to their financing- inevitably produced in quantities that are too small due to the existence of free riders (medical research, agricultural research, environmental protection) etc…
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Chapter 5 Globalisation developed countries
and
inequalities
within
In recent years, certain evolutions give cause for concern: -
first, a vision of the South shackled by labour-intensive industries, which is far from reality, as witness the emergence of technological product lines in Asia44. secondly, integration in international trade, which concerns a growing number of countries including such demographic giants as China, India, Indonesia and Russia. Will this demographic boost mean a correspondingly stronger impact of low-wage emerging markets on the rich countries?
These are important issues. Here, we will try to determine whether or not underemployment, increasing unstable employment and declining real wages in the United States are due to new forms of competition connected with globalisation.
The losers in the globalisation process The losers in the globalisation process are those whose wages diminish as trade increases45, i.e. those who are less in demand. We must therefore ask ourselves what effect globalisation has on demand for production factors. It is generally agreed that labour (as opposed to capital) loses out in globalisation, more precisely unskilled labour (as opposed to skilled labour).
First approach: growing wage inequalities The HOS theory46 offers a clear solution: trade prompts the North to specialise in products requiring intensively skilled labour and the South in products requiring intensively unskilled labour. Consequently, globalisation automatically increases inequalities in the North between unskilled and skilled labour. The losers in the globalisation process are the unskilled labourers. 44
Even if, in the long term, wages can be expected to catch up to the degree that the Asian countries are catching up with Western productivity. 45 Even those who are no longer employed if their remuneration cannot be lowered. 46 See Appendix 3.
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Globalisation nevertheless has a different effect according to whether or not wages are flexible: -
when wages are flexible, competition from low-wage countries lowers the wages for unskilled labour in the North; in return, demand from the NICs for imported capital goods will raise wages for skilled labour in the developed countries and so worsen inequalities;
-
by contrast, when low wages cannot be lowered, unemployment increases among unskilled workers; moreover, in the case of unemployment benefits, skilled workers may also find themselves in a less attractive position since they will have to pay for the benefits of unskilled unemployed persons and so inequalities worsen less than in the first case.
While the HOS theory provides for worsening wage inequalities in the North, it gives a rather perfunctory explanation (inequalities are due to changes in the demand for factors supported by trade in goods). The current debate endeavours to come up with more filledout explanations for wage divergences.
Reasons for labour inequalities
The inequalities on the labour market are due to the fact that each category of employment has a different destiny in a globalised environment: Highly skilled workers have the wind in their sails. Reich (1991) calls them the "symbol manipulators" (researchers, engineers, lawyers, IT experts, consultants, advertising specialists, journalists, etc.). Their common denominators are advanced studies, a creative job content and global competition. Growing global demand for ideas and innovations allows both their numbers and their remunerations to increase. They take advantage of the new international labour divide (design and development in the North – manufacture in the South). Conversely, demand for unskilled workers is diminishing for two reasons: -
they are beset by competition from unskilled labour in the developing countries; they are sidelined from the production system since they do not master the new technologies: this is known as "skill-biased technological progress".
Assuming that these two factors explain declining demand for unskilled labour (and therefore lower remunerations), where lies the responsibility of globalisation? It is obvious that the first factor is directly linked to globalisation. Nevertheless, its impact is very limited: products manufactured in and exported by the developing 59
countries account for only a small fraction of imports in the industrialised world, let alone GDP (on average 2%). Moreover, the volume of foreign direct investment remains limited. The debate focuses primarily on the second factor (technological bias), opposing two positions: -
-
according to Krugman (1996), the decrease in the real wages of unskilled workers is not due to international competition but to technical progress, which is different; by contrast, other authors47 believe that the opposition between internal factors (technological revolutions) and external factors (competition from the South) is largely artificial: the race for productivity gains and automation is an aspect of the competition between the economies of the North in order to dominate sectors not yet invested by the developing countries. Moreover, it is not necessarily valid to distinguish between trade flows and flows of ideas transmitted through the internet: the problem is not whether trade or technological development is responsible for the declining living standard of unskilled workers, since both are facets of the same globalisation process.
Globalisation forces the North to convert to design and development activities, which require a good grasp of technical tools and rule out unskilled labour. So globalisation explains the new labour division and generates inequalities in the North.
In this sense, globalisation is a process of "creative destruction": internal inequalities could be said to be the corollary of the change in the distribution of comparative advantages at a global scale. This creative destruction shows typically in the migration of workers from traditional sectors to innovative sectors, which is costly in terms of unskilled labour.
Labour and capital
The remuneration of the labour factor in general is decreasing. Rodrik (1997) asserts that globalisation makes labour demand more elastic. Workers are losing both negotiating power and job security. Globalisation can indeed have a negative impact on labour through another channel. We have already seen that globalisation increases competition on the labour market with lowwage countries and so reduces demand for unskilled labour in the developed countries. However, globalisation also aggravates competition on the goods and capital markets, thus making labour demand more elastic. 47
See Adda (1998) for example.
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As Rodrik shows, workers are losing their negotiating power and are having to settle for less stable remunerations and working hours in an effort to cope in response to the shocks. Labour is therefore once again the great loser in the globalisation process but for another reason than the above: there is less job security.
Outlook
There are nevertheless signs of hope in the long term. The demand for unskilled labour in the North is unlikely to disappear and can even increase, as the following elements show: - Krugman (1996), one of the pioneers of the theory of skill-biased technological progress, is less alarmist than he seems. In his view, technological progress will not necessarily continue to favour highly skilled workers. Future technologies may themselves make skilled labour redundant, as witness the history of weavers at the beginning of the 19th century, whose wages soared after the invention of the spinning machine and subsequently crumbled when the technological revolution affected their own profession. Krugman predicts that "the era of inequality will make way for an era of equality". Conversely, technological progress may end up strengthening demand for unskilled labour (e.g. call centres, where unskilled workers answer intricate questions using consultancy software). There is no reason why skilled labour should remain the complement of capital in the future… - Secondly, fast response to the market has become a key ingredient of corporate strategies, promoting concentration of activities instead of relocation. For example, Zara (garments brand) runs a just-in-time production system; it manufactures only 15% of its output at the start of the season. It concentrates its production in Spain in order to stay in tune with changing consumer tastes (working with local suppliers allows it to develop quickly new fashion lines) and uses judicious transportation solutions to keep close to foreign markets (input by the media, managers who make plane trips, etc.). So globalisation and transportation revolution don't lead necessary to relocation of activities but enable a firm to respond to the markets without dispersing its activities.
French responses to globalisation We will successively examine the institutional solutions and the reactions of French citizens to the effects of globalisation on inequalities.
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The adjustment process
Sapir (2000) has made a comparative study of institutional globalisation solutions: Europe and the United States have respectively adjusted themselves to globalisation by means of volume solutions (unemployment and part-time jobs) and pricing solutions (growing wage inequalities). This has reduced inequalities in Europe and aggravated them in the United States. Compensation systems differ from country to country: the United States has a special social programme (TAA, Trade Adjustment Assistance) offering certain benefits and reemployment services to workers affected by trade liberalisation, whereas in Europe such workers are protected by the welfare state. The outlook is not the same: the Europeans consider competition from low-wage countries is a problem in equity whereas the Americans tend to consider it a problem in efficiency. This explains the differences in success in both areas: European social policy has limited inequalities of income and poverty more successfully than its American counterpart (in the mid-90s, the ratio between the share of income accruing to the highest decile and the share earned by the lowest decile was equal to 17 in the United States, compared to an EU average of 8). By contrast, American social policy has used the workforce more efficiently: at the end of the 90s, per-capita income in the United States was 50% higher than in Europe due to the difference between the unemployment rates of both areas. In fact, the non-egalitarian dimension of globalisation is not the foremost concern of the United States, which looks at the problem from the angle of efficiency.
The perception of globalisation Fougier (2001) gives a rough outline of public reaction to globalisation. People in France and the United States experience a three-fold feeling of insecurity, dispossession and powerlessness vis-à-vis globalisation. The feeling of insecurity may be due to a kind of breach of the fordist contract of the thirty growth years after the Second World War. It is accentuated by the perception of layoffs at profitable businesses (the survey panel felt that troubled businesses should lay off while profitable businesses should hire). The feeling of dispossession is prompted by the impression that decisions regarding the people are taken without consulting or factoring in the concerns of the people. This impression is strengthened by the supposed powerlessness of governments vis-à-vis the major globalisation players (the financial markets, multinationals, multilateral organisations). Lastly, the feeling of powerlessness is linked to the idea that globalisation is an irreversible process without alternative to which individuals and governments are obliged to adapt. 62
All the same, the surveyed panel did not consider globalisation wholly negative. Their position was both more subtle and more paradoxical. They felt that globalisation has positive consequences for the economy and the country as a whole but negative consequences for themselves. More exactly, they felt that globalisation benefits businesses and the moneyed classes but has a negative impact on the jobs and wages of the poorest workers and, more generally, that it aggravates inequalities and reduces job security. There is therefore a widespread idea that globalisation is good for the economy and bad in social (and even cultural) terms. The social discrimination attributed to globalisation (which benefits the social classes unevenly) is reflected in the surveys: globalisation tends to be perceived negatively by th most vulnerable people, which is consistent with the hypothesis that globalisation helps exclude unskilled labour from the production system. By contrast, the well-off are in favour of globalisation. Another recurrent aspect is the demand for transparency and democratisation of institutions and organisations, reflected in a certain sympathy for protest movements against the ongoing globalisation process, who denounce its negative consequences. More generally, citizens want to be better informed and to take part in decision-making bodies and key negotiations to bring about "another type of globalisation". The demand for democracy is relatively independent from other criticism of globalisation, since it is felt strongly even in countries in favour of globalisation. In France, 46% of those panel members who welcomed globalisation tended to put their faith in "associations fighting for another type of globalisation". Lastly, the perception of globalisation differs from country to country. The French perceive the financial dimension of globalisation and its consequences for France's national and cultural identity. The threat is specially felt to come from such multinationals as Mc Donald's. In the United States, globalisation is primarily connected with trade liberalisation and competition from low-wage countries (Mexico and China), which jeopardises jobs and wages.
Policies to fight inequalities It is a striking fact that internal inequalities have evolved in many different ways in the industrialised countries, even though these countries often face the same globalisation phenomena and technical progress. Thus, these two reasons do not entirely explain inequalities. The variety of national experiences is also due to internal policy choices. In fact, the evolution of internal inequalities partly reflects the will of the government and the preferences of the population. Moreover, studies of internal inequalities stress the important role of public policies. The CAE report (2001) underscores the persistence of different labour-market transfer and organisation models in rich countries, explaining most of the contrasting internal 63
developments in countries where a priori the same process is taking place. It inter alia indicates that only half of the strong increase in inequalities of income in Great Britain between 1977 and 1990 is due to market developments as the other half is due to lower redistributive social transfers. Conversely, Canada, whose labour market is very similar to the US market, does not experience the same increase in inequalities of disposable income since it uses transfers to correct growth of market inequalities. Thus, globalisation definitely sparks non-egalitarian internal trends but every country has its own means of reducing them according to national preferences.
Why fight internal inequalities? For many years, the consensus was that we have to choose between growth and equality. If we want a more egalitarian society, we need to accept lower growth. Today, the view has changed: -
first, economists agree that internal inequalities primarily reflect internal policy choices and national preferences; secondly, the assumption that equality comes at a growth cost implies that inequalities are efficient and redistribution distortive; however, it is currently acknowledged on the contrary that excessive inequalities are a source of inefficiency.
Means to fight internal inequalities
1. Short-term measures Palliatives in the short term: the priority is to offset the effects of globalisation on unskilled labour. a. redistribution The fight against inequalities first calls for the implementation of redistributive policies: from capital to labour and for labour, from highly productive sectors to sectors exposed to competition from low-wage countries. In other words, to reduce inequalities we must begin by maintaining unemployment benefits and social minima. The underlying stakes are as follows: globalisation accentuates inequalities on the labour market (inequalities of wages and inequalities of access to jobs) and so breaks the fordist contract of the thirty years of growth, during which redistribution ensured relatively even remunerations. Globalisation is therefore a challenge for the redistribution systems, which need to counter the non-egalitarian logic forwarded by globalisation.
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b. Subsidies Now let us look at the most frequently mentioned solution, which is to lower charges on unskilled labour. This measure affects unskilled labour two ways: -
internationally, by improving competitiveness: lower charges reduce the relative price of domestic goods in sectors exposed to competition compared with foreign goods and encourages hiring in the exposed sectors. However, this effect is limited.
-
domestically, by reducing the relative cost of unskilled labour compared with capital and skilled labour, which leads to the following two substitution effects: 1 a microeconomic effect (businesses start using more unskilled labour compared with skilled labour and capital) but the effect is slow (the production structure needs to be modified) and limited (skilled workers are not laid off because the cost of unskilled labour decreases). 2 a macroeconomic effect: lower prices for goods requiring intensive unskilled labour raise demand for such goods.
Conclusion: the decrease of social security charges creates jobs, not so much by modifying the production organisation but by directing household consumption to goods requiring intensive unskilled labour (especially services).
c. Less exposure to competition from the developing countries Businesses in sectors requiring intensive unskilled labour develop strategies based on non-cost advantages (quality, proximity to the market, rapid adjustment to demand, creativity, etc.).
2. Long-term measures In the long term, the problem needs to be tackled at the root by avoiding downward levelling, i.e. by preventing the reduction of inequalities by downward adjustment of wage distribution. This can be done in two ways:
a. Promoting skills in the North The objective here is to raise the qualification level and to encourage retraining in order to avoid an unbalanced redistributive configuration (taking much from few people and 65
redistribution little to the greatest number), which would level the remunerations of Western workers downwards. According to Reich (1991), State intervention is indispensable: the backbone of American economic policy must consist of public spending to improve the capacity of individuals to enhance their skills (quality education and infrastructures). This is obviously a new view in the United States, where public investment has decreased sharply in recent decades. The State must also subsidise businesses - without distinguishing nationality – with high value-added production on national soil, in order to promote learning among the working population.
b. Dissemination of social patrimony in the South We must avoid a deregulation rush, which is another form of downward levelling and promote the dissemination of the social patrimony of the North. This is nevertheless problematic since we cannot require the countries of the South to comply with the employment standards of the industrialised countries (it would be a form of disguised protectionism). Moreover, wages reflect average productivity in a given economy. Hence, it is normal for wages to be lower in the developing countries, since average productivity is lower (it allows such countries to acquire a comparative advantage in sectors, where productivity is relatively high)48.
The measures to fight inequalities go hand in hand with the rehabilitation of public intervention. Paradoxically, however, the reduction of inequalities does not necessarily call for increased redistribution. The government has other ways to reduce49 inequalities, such as retraining and the development of efficient infrastructures.
Financing the fight against inequalities
Globalisation not only increases internal inequalities but also limits the possibilities to reduce them. It should be remembered that the only period in which internal inequalities decreased (at world level) was the period from 1910 to 1950, a period of lower trade openness for the national economies. It could be supposed that lessening globalisation made it possible to reduce inequalities by giving nations much more room for manoeuvre (particularly in monetary and tax terms) than during the intense globalisation phase prior to 1910.
48 49
See Landau and Benaroya (1999). A distinction could be made between passive and active reduction of inequalities.
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Today, the debate focuses primarily on tax policy, which is a favoured adjustments policy to reduce inequalities.
1. Threats besetting the tax instrument Globalisation improves the mobility of tax bases (mainly savings investments, businesses and to a lesser extent human resources) and so jeopardises the independence of national tax systems: the factors may endeavour to avoid taxes considered too high by moving to a location with a friendlier tax environment (tax havens in extreme cases). In the light of this situation, countries are tempted to lower taxation in order to attract new assessment bases. Indeed, the ongoing evolution of corporation tax rates in Europe suggests the existence of tax competition, in that the weight of corporate taxation is steadily going down. More generally in the European Union, taxes and social security charges tied to mobile assessment bases (corporation tax and employer contributions) have increased much less than taxes and social security charges on less mobile bases (consumption, employee contributions and personal income tax). The positive effect of this tax dumping for a country is limited to the short term: when other countries start competing, the State will merely lower its tax rates without enlarging its assessment basis and so receive less revenue.
2. Effects on inequalities All this merely worsens inequalities, since tax revenues are partly used to redistribute wealth. However, inequalities are also affected in another way: governments may be tempted to offset loss of tax revenue due to competition by raising taxation of the least mobile bases. These generally correspond to the poorest classes. In other words, the tax consequences of globalisation have a two-fold effect on inequalities: -
the resources available to fight inequalities are reduced by tax competition. under pressure from this competition, taxation of the least mobile assessment bases tends to go up while mobile assessment bases become free riders (they benefit from public spending without contributing to their finance).
3. Proposals - Tax harmonisation is difficult to implement, notably because of the refusal of countries to abandon their tax sovereignty (countries consider it necessary to preserve certain taxes, such as those which help to finance social security charges).
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- Businesses could be made to pay taxes based on the tax system of their home country. Businesses would nevertheless be inclined to establish their registered office in a country with a more attractive tax system. (This is a genuine risk: the Netherlands offers attractive tax rates for holding companies and so attracts the head office of major European companies.) - The most mobile businesses should be given the status of a European company and be taxed directly at European level. This would be a way to restore tax sovereignty, just as the EMU was a way to restore shared monetary sovereignty after national sovereignty had been reduced in the ERM.
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Appendix 1: interpretation of figures First of all, in comparing income in different countries, the figures must be converted using the PPP exchange rate in order to factor in price differences between countries. Price differences are especially important for the developing countries, whose domestic prices deviate from world prices due to the weight of output for the domestic market and the volatility of exchange rates. Without PPP conversion, inequalities are significantly overestimated. Next, inequalities must be examined over the entire range of income distribution and not just at the distribution extremes. Hence the need to use the Lorenz curve and the Gini coefficient. The spread between the extremes is frequently used to measure inequalities; but while it is true that extremes are nowadays farther apart than in the past, this cannot be considered an increase in inequalities, for although certain economies have remained on the sidelines, others have posted spectacular successful economic performances. Moreover, income comparisons must cover all countries, not only special cases (for instance, China is often excluded from the statistics, whereas it significantly helps to reduce international inequalities and global inequalities despite worsening internal inequalities). Lastly, the poorest countries do not remain the same over time. Thus, the widening gap in income between the richest and the poorest countries conceals the fact that the poorest account for a steadily declining fraction of the world population, ignoring the catch-up by densely populated countries.
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Appendix 2: international trade theories50 Ricardian theory Ricardo ascribes the origin of trade to differences in productivity. It is in a country's interest to specialise in a good in respect of which it enjoys relatively high productivity. This is the theory of comparative, not absolute advantages, i.e. it is in the interest of a country to specialise, even if it is more efficient when producing all goods. To understand this paradox, we need to remember that a country's specialisation does not just depend on its productivity (a real concept, which measures the technical efficiency of production; the more productive the country, the more sophisticated its technology and the higher its production for a given quantity of production factors) but also on its costs, especially wage costs. A country may well be more productive than its neighbour but if its wages are much higher than elsewhere, its competitiveness may actually be low. It can be shown that, due to the way wages are formed (at a country's average productivity level), when a country is more productive for all goods, it cannot be competitive for all products. This is intuitively understood: a very productive country has high wages, offsetting its advantage and limiting its competitiveness in certain goods. History is a simple sequence for Ricardo, who illustrates his theory with the cases of Portugal and Great Britain, respectively specialised in the production of wine and cloth. After specialising in wine, Portugal reassigned workers from cloth manufacture to wine production. It was able to trade its surplus wine for British cloth and as Great Britain manufactured cloth with relatively high efficiency, Portugal obtained more cloth than it could have produced locally.
50
For more details, see Benaroya and Landau (1999) or Krugman and Obstfeld (1994).
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Heckscher-Ohlin-Samuelson theory This theory, which builds on Ricardo's theory, explains the existence of comparative advantages by a relative abundance of factors instead of technological differences. Let us take a world in which two countries (North and South), each with two production factors (unskilled and skilled labour - the same reasoning could be applied to the labour and the capital), produce and trade two goods (textile and software). Textile manufacture requires proportionally more unskilled labour whereas software development requires more skilled labour. We will assume that competition is perfect, that there is no difference in production technology between the two countries (same level of productivity) and that there is no underemployment. Lastly, the North country is more industrialised than the South country and so has more skilled labour. 1st conclusion: each country will specialise in the good requiring intensive use of the factor with which it is best endowed (compared with the other country). Unskilled labour is in short supply in the North and therefore more expensive than in the South (compared with skilled labour). This is why the North is a relatively less efficient manufacturer of textile than the South. Compared with the price of machines, the price of textile is higher than in the South. Conversely, software requires intensive use of skilled labour, which is available in abundance and therefore less expensive. It is therefore in the interest of the North to specialise in the manufacture of computers and to export them. In return, it will be able to import textile at a relatively low price from the South. As a result, the overall wealth of both countries will increase. 2nd conclusion: Heckscher-Ohlin-Samuelson theory The relative demand for skilled labour and therefore the relative price of this factor will increase in the North and decrease in the South. The prices of the production factors will therefore tend to level out internationally even without any international mobility of production factors. 3rd conclusion: Stolper-Samuelson theory The increase in the manufacture of computers in the North increases the demand for skilled labour in the North and therefore its real remuneration. Conversely, the demand for unskilled labour decreases. According to the Stolper-Samuelson theory, the remuneration of the abundant factor and the scarce factor will increase and decrease, respectively. Thus, trade has a redistributive effect on the internal distribution of income: the possessors of the scarce factor lose out in the exchange.
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Appendix 3: Growth and convergence Determinants of growth The general framework for reflection is the Solow model (1956). This is an "exogenous growth" model in that it does not ascribe long-term growth to the conduct of economic agents (e.g. the amount of investment) but to exogenous factors such as population growth. This conclusion flows from the model's basic assumption that the marginal productivity of capital decreases. In other words, when the capital supply increases, the resulting increase in production becomes gradually smaller. As a country continues to develop and reinvests a constant fraction of income it accumulates less and less since such reinvestments generate less production. Growth begins to stagnate after a certain time. In the long term, accumulation is just enough to equal population growth, which means that per-capita investment and production cease to increase. This is known as a "stationary state". In the original model, there is therefore no growth other than population growth. The model can only predict positive per-capita growth if it is enriched with another factor. This factor is exogenous technical progress. This implies gradually improving productivity of labour and/or capital. Once the stationary state is reached, long-term growth factors reflect technical progress and population growth. However, this remains an unsatisfactory long-term growth analysis since the assumption that technical progress exists is added ad hoc instead of being explained by the model itself, as would an endogenous growth model. The second generation of models consists of endogenous growth models, which stress that growth can maintain itself (it depends on the conduct of economic agents instead of on exegeneous factors). These models rejects the hypothesis of decreasing capital returns on the assumption that the efficiency of the production factors themselves improves over time. This transformation of factors may be due to the accumulation of capital (learning process, induced technical progress) or be the result of a deliberate choice (e.g. time and resources earmarked for training).
Convergence The Solow model shows the property of convergence51, according to which poor countries will catch up to the rich countries. When two countries have the same 51
"Convergence" occurs when a country's growth rate is even bigger than its initial per-capita income is law.
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population growth and different per-capita capital growth, the capital-poor country will enjoy faster growth than the rich country since the marginal productivity of its capital is higher. As the poor country catches up the rich one, declining marginal productivity of capital means decreasing capital returns, thus reducing accumulation. Consequently, the two countries will gradually tend toward the same level of per-capita capital and output However, the convergence property of the Solow model has been criticised. First, there is no empirical evidence of a decreasing relation between the growth rate of countries and their initial level of income. Instead, we tend to see so-called twin peaks (Quah, 1996), i.e. "convergence clubs". In other words, there are two groups of converging countries but there is no convergence between the two groups. Mankiw, Romer and Weil (1992) have also shown that there is no absolute convergence of the kind posited in the Solow model, but that convergence is conditional upon a country's savings rate (s) and population growth rate (n). This means that a country's catching up does not just depend on the distance to the stationary state but also on its own characteristics (as the stationary state itself is dependent on s and n). For example, a poor country far below its stationary state but with a low savings rate could have a lower growth rate than a rich country even though the latter is close to its stationary state. The lack of convergence between wealthy and poor countries is therefore due to the fact that they do not have the same investment rate or the same population growth rate.
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