Globalization, Poverty, and Inequality || Why Global Inequality Matters

Why Global Inequality MattersAuthor(s): Nancy BirdsallSource: Brookings Trade Forum, , Globalization, Poverty, and Inequality (2004), pp. 297-303Published by: Brookings Institution PressStable URL: http://www.jstor.org/stable/25063198 .

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NANCY BIRDSALL Center for Global Development

Why Global Inequality Matters

Taking

the perspective of a development economist, and reflecting on issues

raised by participants in this forum, this paper elucidates why inequality (and not just poverty) matters, among individuals and across countries, and why global

inequality matters in the context of globalization. The focus is on the current

asymmetries in how global integration affects poor versus rich countries (and

people within countries), and on the resulting limits to poor countries' (and poor

people's) ability to capture the potential benefits of globalization. These asym metries reflect and reinforce existing levels of inequality across and within

countries, and raise the risk that globalization will leave some countries and some

poor people behind.

Why Inequality Matters

Among economists concerned with developing countries two decades ago,

inequality was virtually a taboo subject. The "development" issue that mattered

was "absolute poverty." For example, the 1990 World Development Report on

poverty refers only briefly to inequality, making the distinction between inequal

ity and absolute poverty.1 This forum is a reminder of what has been a dramatic,

decade-long burst of new research on income inequality and its causes and con

sequences in an increasingly integrated global economy.

Moreover, now economists take it almost for granted?at least, that has been

the case in this forum?that inequality matters not only because it affects growth or other economic variables but in and of itself. That seems to break another con

ventional taboo. From the new research on happiness, for example, comes the

1. World Bank (1990). That 1990 report was led by Lyn Squire, who later with Klaus Deininger made a notable contribution to economic studies of inequality by compiling the widely used

"Deininger and Squire" country data set on income distribution (Deininger and Squire, 1996).

297

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298 Brookings Trade Forum: 2004

sense that people care about inequality?in their own communities, in their coun

tries, in the world.2 Different societies tolerate different amounts of inequality, but beyond some level, inequality enters as a "bad" in utility functions.

Regarding inequality among individuals, people not only care about their rel

ative standing (in terms of income) but about the expected change in their standing. To put it in more conventional terms, they care about the opportunities they and

their children face and how those opportunities will affect their future relative

income. With respect to the future, they care, as Albert Hirshman illustrated with

his metaphor of being stuck in the tunnel while those in the other lane are mov

ing ahead, about fairness?where others like them are likely to get to.3 They may care more about their expected future, in the context of what seems fair com

pared to others in some self-defined ("horizontal") category, than about anything economists can measure today.

Actually, and to complicate matters further, with respect to expected changes in their position, people may not care about change in their relative standing in

the way that economists tend to think about and measure it. Economists view

change in relative standing in proportionate terms: by what percentage did my income versus her income increase? (Or by how much did the ratio of my ver

sus her income to the mean change?) Yet people may care more about change in the absolute difference between their and their counterparts' income?what

Martin Ravallion, citing Serge Kolm, calls "absolute inequality."4 This term

absolute inequality is confusing since inequality is, by definition, a relative term.

Perhaps it should be called "difference" inequality, to distinguish it from "ratio"

inequality. Difference inequality is especially important in the context of globalization.

Even with similar rates of income growth across countries, absolute differences

in income between the rich and the poor continue to increase. Even if growth is

just as good for the poor as the rich in terms of the growth rate, the poor may feel

increasingly worse off and thus, as Carol Graham suggests, frustrated despite their income gains.5 The annual average income of a Mexican in the second quin tile of the income distribution was about $1,300 in 2000 (in constant 1995 U.S.

dollars). If she shared proportionately in a healthy overall growth rate of the econ

omy of 5 percent, her absolute gain would be $65. But her rich neighbor's

proportionate gain, starting from $20,000, would be $ 1,000, widening the absolute

gap in their incomes by $935.6 She still cannot afford to buy another pair of global

2. See Carol Graham in this volume.

3. Hirshman (1973); see also Birdsall, Graham, and Pettinato (2000). 4. See Martin Ravallion in this volume and Kolm (1976). 5. See Graham, this volume.

6. Average per capita income in the fifth quintile of Mexico's income distribution in 2000 was

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Nancy Birdsall 299

brand sneakers, while her neighbor's gain would have nearly doubled her total

income. Making matters worse, the price of those global brand sneakers may itself have increased because the effective demand of her richer neighbors for

global goods has grown with their large absolute income gains. Moreover, "glob alization" may have changed her reference group and her consumption goals: the

global brand sneakers may seem necessary to avoid Adam Smith's "shame" of

failing to meet the common standard.7 With an increase in difference or absolute

inequality, the lower-income person may thus suffer both the Weberian-type envy that Richard Easterlin describes and a negative pecuniary externality if rising aver

age consumption in his or her society raises the relative prices of certain favored

goods.8

Inequality across individuals or households?or, for that matter, across occu

pational, regional, ethnic, or other categories of people?matters not only in and

of itself but also for its impact on other outcomes. Economists are particularly concerned with the effects of inequality on growth and, more recently, on poverty. The issue is not so much any direct effects of inequality on growth and poverty.

Rather, where market and policy failures of the sort Pranab Bardhan describes

abound?as is the case in developing countries almost by definition?inequal

ity is likely to interact with those failures to magnify their negative effects on

growth.9 So inequality may impede growth (and poverty reduction, which depends in part on growth) in the very settings where growth can bring the greatest

improvements in human well-being. Some years ago, Robert Barro regressed

growth on inequality (and the other standard variables in growth regressions),

distinguishing between advanced and developing economies.10 Inequality seemed

to be good for growth in the former and bad in the latter. In the former, inequal

ity may well be constructive, reflecting real differences in productivity and work

effort and generating incentives for innovation and work. In the latter, where mar

ket and policy failures abound, inequality may be socially destructive, reflecting real differences in opportunities and reinforcing the discouragement and dis

criminatory practices that market distortions and policy failures have created.

Inequality may matter not only for growth and poverty reduction but may undermine the political process, especially in developing countries where exist

ing political institutions are weak and politics is not particularly representative. Nicholas Sambanis points to some evidence that inequality may raise the risk of

about $ 11,000. Data from World Bank (2004). Many individuals would be substantially above that

average. 7. Smith (1904). 8. Easterlin (2003). On the effects of changing consumption norms, see Hojman (1999). 9. See Pranab Bardhan in this volume.

10. Barro (1999).

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300 Brookings Trade Forum: 2004

civil war by inducing political instability. In the extreme, it may be a factor that,

interacting with weak institutions, triggers civil conflict and violence.11

Inequality may also undermine social and civic life. The evidence that crime

is associated with high income inequality suggests the nature of the problem: frustrated envy, particularly if there is a perception of not only unequal outcomes

but unequal opportunity. The concept of social capital (including the public good of "trust" in a society) was not discussed in this forum. But where high inequal

ity combines with limited social capital, its effects on well-being can extend to

the affluent as well as the poor, limiting enjoyment of public parks and use of

convenient public transportation. Of course, there has been much more convergence across countries in certain

health and education indicators than in income.12 This convergence seems to be

the result of the spread of ideas and technology?an important benefit of glob alization?more than of a reduction in the market and policy problems of

developing countries. But in these areas, there may be less convergence than the

aggregate indicators suggest, if the quality of health and schooling is not improv

ing sufficiently in developing countries. In Latin America, the relative declines

in the returns to primary and secondary versus tertiary education surely reflect, in part, the poor quality of the schooling at those levels. Regarding health, there

may be less convergence of people's overall health status (or nonmorbidity) in

poor and rich countries than in life expectancy; the increase in life expectancy in

poor countries reflects success in reducing infant mortality more than in man

aging people's health throughout their lifetimes.

Convergence between the rich and poor worlds in health and education indi

cators is a welcome sign of gains in human well-being. But it does not necessarily indicate development progress defined as sustainable transformation of the world's

poorest economies.

Globalization and Global Inequality

Whether increasing or declining somewhat with globalization, the fact is that

the absolute differences in income between rich and poor countries, and between

rich and poor people in the world, are enormous. Global inequality is, in other

words, very high?no matter how it is measured.13 It is probably wrong to believe

that globalization in itself (no matter how defined) is worsening global inequal

11. See Nicholas Sambanis's paper in this volume, which links poverty and political violence.

12. See Angus Deaton in this volume and Barro and Lee (2000). 13. Milanovic (2003).

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Nancy Birdsall 301

ity. But in the poorest countries (and for the poorest within countries), global ization may well interact with existing high levels of difference inequality to hinder

their growth, making it appropriate to refer to globalization as asymmetric in its

effects. There are three asymmetries in the way increasing global integration affects poor countries and poor people.14

First, the bigger and deeper markets of the global economy reward most the

people and the countries with the assets needed to exploit those markets. In the

case of people, a critical asset is human capital. Rising returns to education, espe

cially to the global good of higher education, account for a good deal of rising income inequality within countries.15 In the case of countries, the critical asset

seems to be sound, reliable political and economic institutions. These are the key to explaining, in William Easterly's "productivity world," the growing divergence in income between the richest and poorest countries?mostly reflecting the fail

ure of the latter to manage positive per capita growth over the last two decades.16

Countries, for example, that depend heavily on primary commodities and cer

tain mineral and other natural resources appear to be relying on the wrong assets

in today's global economy.17 Global integration is by its nature disruptive. That need not be bad in itself.

But people and countries that are poor?in human capital and in the right insti

tutions?have less capacity to adjust to changes in prices and opportunities, and

less capacity to cope if they cannot quickly adjust. In the case of the poor, what

is a short-term shock may put them on the wrong long-term equilibrium path (for

example, if they sell productive assets to maintain consumption during a down

turn).

Second, unattended market failures at the global level are likely to hurt the

relatively worse off relatively more. The welfare costs of global warming are

likely to be greatest in low-income countries. The volatility of global capital mar

kets has been particularly costly for emerging market economies.

Third, the rules of the global economy, and their implementation, tend to favor

the rich and powerful, reflecting the latter's ability to shape the rules in the first

place. The global trade regime is still far from a level playing field; the interna

tional labor market is highly restricted, and so on.

These asymmetries arising from unredressed market and policy failures at the

global level, combined with institutional and policy failures in poor countries,

raise the risk of poor countries being stuck on a path to the wrong equilibrium

14. Birdsall (2002). 15. See Goldberg and Pavcnik in this volume, in which they discuss the evidence linking trade

liberalization to the rising skill premium in developing countries.

16. See William Easterly in this volume.

17. Birdsall and Hamoudi (2002).

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302 Brookings Trade Forum: 2004

of low growth, high poverty, weak institutions, and resulting entrenched poor

policy. In the absence of some change in these asymmetries of global integra

tion, poor countries and poor people may continue to be left behind?and

divergence between the richest and poorest countries is likely to persist.

Conclusion

In the long run, globalization can make a positive difference, reducing poverty and global inequality. But it also brings costs and risks. There is not only the cost

for individual losers (whose losses may be more than offset by others' gains, of

course), but the risk that entire countries and their peoples will get onto the wrong

path altogether, leading to the wrong low-level equilibrium. That risk suggests less religiosity on the content and sequencing of market

and other economic reforms in the poorest countries, and more emphasis on build

ing resilient economic and political institutions. Unfortunately, existing research

does not provide much guidance on how to build institutions, except to make the

point that local conditions and local innovation are key.18 In addition, that risk

suggests more attention to "managing" the globalization process, with a focus

on minimizing the economic and other?for example, cultural and environmen

tal?risks to the poorest countries and peoples that increasing integration of

global markets brings. In a forthcoming book, Carol Graham, Sandip Sukhtankar, and I discuss the need for a global social contract.19 That would imply

?bigger transfers from rich to poor countries that are much better focused on

long-term institution building and on creation of assets and opportunities for the

poor; ?renewed attention to the kinds of global standards and regulatory regimes,

in such areas as international capital flows, that would minimize the costs to poor countries of market and policy failures;

?and new thinking about democratic governance in our international finan

cial and other institutions, in the hope that better representation of poor countries

would ultimately lead to rules and customs for managing global integration that

are fairer as well as more efficient and effective.

18.Rodrik(2000). 19. See Birdsall, Graham, and Sukhtankar (forthcoming).

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Nancy Birdsall 303

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versity, Department of Economics (June).

Barro, Robert J., and Jong-Wha Lee. 2000. "International Data on Educational Attain

ment Updates and Implications." Working Paper 7971. Cambridge, Mass.: National Bureau of Economic Research.

Birdsall, Nancy. 2002. "Asymmetric Globalization: Global Markets Require Good Global Politics." Working Paper 12. Washington: Center for Global Development (October).

Birdsall, Nancy, Carol Graham, and Stefano Pettinato. 2000. "Stuck in the Tunnel: Is Globalization Muddling the Middle Class?" Working Paper 14. Brookings, Center on

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Birdsall, Nancy, Carol Graham, and Sandip Sukhtankar. Forthcoming. Narrowing the Global Divide: Poverty, Inequality, and the Global Social Contract. Brookings and Center for Global Development.

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