Why globalization doesn’t lift all boats
Nancy Birdsall is the founding president of the Center for Global Development. She has previously held senior positions at the Carnegie Endowment for International Peace, the Inter-American Development Bank, and the World Bank. Her essay is based on her 2005 UNU-WIDER (United Nations University World Institute for Development Economics Research) Annual Lecture. The full lecture is available on the Web site of the Center for Global Development at www.cgdev.org
After spending the late 1980s working on Latin America for the World Bank, I became involved in a major study of East Asia’s postwar growth. The contrast between the two regions was notable: Latin America was stagnating while East Asian economies were growing rapidly, with tremendously high rates of private and public investment and savings. The emphasis on exports and the pressure to compete in global markets seemed to have worked.
The impressive growth in Taiwan, Korea, Hong Kong, and Singapore, and later in Malaysia, Indonesia, and Thailand, reflected and was reinforced by equally impressive changes in people’s behavior and lives: unprecedented gains in small farmers’ productivity, high demand for schooling (including schooling for girls), and declines in fertility far steeper and at lower income levels than in industrialized economies. These changes contributed to income gains for households that, in a virtuous circle over many years, fueled further economic growth, demand for education, productivity increases, and declines in fertility. I was familiar with many of the household-level changes through my earlier research in the postwar developing world. What particularly surprised me was that the rapid growth had not led to higher inequality.
Textbook economics describes a tradeoff between growth and equality. Increasing inequality (as in China today) seems to be a natural outcome of the early stages of development, for example as the shift from low-productivity subsistence agriculture to high-productivity manufacturing brings income gains for some people but not for others. In addition, inequality is likely to enhance growth by concentrating income among the rich, who save and invest more. Moreover, inequality reflects a system that rewards hard work, innovation, and productive risk-taking—which ultimately ensures higher output and productivity, and thus higher average income and rates of growth. These inequality-related incentives are the backbone of the argument against tax-financed redistribution: such transfers undermine individual responsibility and the work ethic and thus slow growth.
For economists, then, inequality has typically represented at worst a necessary evil and at best a reasonable price to pay for growth. So, for the most part, they have not been concerned with the apparent trend of rising inequality. Development economists in particular have focused instead on the reduction of absolute poverty. But in East Asia the textbook story seemed altogether wrong. One key to East Asia’s success seemed to be its low initial levels of inequality, which were associated with the legacy of postwar redistribution of farm land in the northern economies and with subsequent high public investments in education, agricultural extension, and other programs in rural areas.
In 1993 I left the World Bank to become the executive vice president at the Inter-American Development Bank. By then I was persuaded that Latin America’s high inequality was an economic problem, slowing its growth, as well as a social problem. I advocated more research on the issue. By that time—soon after the fall of the Berlin Wall had liberated the mainstream from the taboo of Marxian thought—academic economists were also beginning to study inequality as a possible cause of low growth, and thus as a phenomenon that mattered, at least for understanding growth itself.
Subsequent work by many economists has strengthened my conviction that while inequality may be constructive in the rich countries—in the classic sense of motivating individuals to work hard, innovate, and take productive risks—in developing countries it is likely to be destructive. That is especially true in Latin America, where conventional measures of income inequality are high. It also may well apply in other parts of the developing world, where our conventional indicators are not so high but there are plentiful signs of other forms of inequality: injustice, indignity, and lack of equal opportunity.
Distinguishing between constructive and destructive inequality is useful. To clarify the distinction: inequality is constructive when it creates positive incentives at the micro level. Such inequality reflects differences in individuals’ responses to equal opportunities and is consistent with efficient allocation of resources in an economy. In contrast, destructive inequality reflects privileges for the already rich and blocks potential for productive contributions of the less rich.
Inequality of income in an equal-opportunity society would be wholly constructive: there would be high lifetime mobility (up and down) and high intergenerational mobility; children’s place in the distribution of lifetime income would be independent of their parents’ place. (Income inequality in the United States is higher than in most countries of Western Europe. The perception of the United States as a highly mobile society compared to Western Europe is likely the result of its higher average income growth, which has lifted all boats.)
Since there are no international measures of relative opportunity or mobility, development economists who care about inequality have been measuring “money inequality”—inequality of income, consumption, and wealth. Assessing the effects of money inequality on growth within and across countries can provide a rough indicator of inequality of opportunity and limited social mobility in a particular setting. This brings us to the crux of why inequality can matter, especially in developing countries. Evidence over the last decade and a half suggests that it has a large destructive component: it is associated with unequal mobility and limits economic growth.
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