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First draft

Is globalization sustainable?

by

Arne Bigsten

GCGD & Department of Economics

University of Gothenburg

171025

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1. Introduction

The post-World War II international order has helped to advance peace and prosperity by increasing

international exchange and connectedness. It has meant increasingly free trade and movement of

capital as well as increasing international migration. This period has seen dramatic economic and

social advances in the world, and until recently there has been fairly broad public support for

increased openness and integration. However, in Western countries there is now a backlash with

increasing hostility against integration and international institutional structures (see Brexit, Trump,

Le Pen etc.). There is a risk that this will undermine the structures that have upheld the global system

since World War 2.

In this paper I discuss what such a backlash might imply for the prospects of development and

poverty reduction in the South. I start by showing some data on the income changes we have seen

there during the last 50 years, which was a period of extensive globalization. I then review the

changes we now see in the world with regard to globalization patterns, followed by some comments

on the Northern backlash against globalization. Finally, I discuss what we should do in terms of policy

to make it possible for the poorest countries in the world to derive benefits from globalization that

can help them reduce the welfare gap relative to the developed counties.

2. Incomes and Poverty in the South

The recent half century has been the most successful in human history in terms of increasing

incomes and reduced poverty. The imbalance between the Western countries and its offshoots and

the rest of the world increased dramatically from the industrial revolution until it peaked in the

middle of the previous century (Maddison, 2006). Since then the dominance of the west has

declined, and the centre of gravity in the world is moving eastwards. We see in Figure 1 that the gaps

between the OECD countries and the rest are still huge, but we also see that during the last decades

there are regions that have grown faster than the OECD. This is particularly the case for East Asia

with China as the driver. The laggards are South Asia and Sub-Saharan Africa, although the former

dominated by India is now growing much faster than previously and much faster than the OECD. The

increase in per capita incomes has also led to extensive reduction in poverty levels as measured by

the World Bank since 1981 (Figure 2). It seems unlikely that this development would have been

possible without the concurrent process of globalization.

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Figure 1: Per Capita Incomes (constant 2011 PPP USD)

Source: WDI 2017

Figure 2: Poverty Headcount (Poverty line of 1.90 2011 USD)

Source: WDI 2017. Missing data for SSA 1981-1987.

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3. Is Globalization Losing Steam?

Globalization has implied a tighter integration of the economies of the world, and this is reflected

particularly in the increasing trade between countries. To a considerable degree this is due both to

the increasing importance of the outsourcing of production and the integration of the financial

system. The global financial crisis of 2008 was a severe set-back for the globalized economic system

and countries turned more inwards. One way to check the degree of economic integration among

the countries of the world is to look at export shares of the various regions. Figure 3 shows that

there was a significant drop in export orientation across the whole world at that time, which is hardly

surprising, but we also see that the trend has not been reversed as yet although economies have

gradually returned to more normal conditions . Actually the share of exports in world GDP peaked

(after the financial crisis) in 2012 at 30.5%, but then it dropped again to 29.4% in 2015. The drop in

the share of exports in GDP in China is even more dramatic from 35.9% in 2007 to 19.6% in 2016

(WDI 2017).

Maybe there are other forces apart from the setback due to the financial crisis that is reversing the

extent of outsourcing and economic integration? When robots can perform more and more tasks it is

maybe becoming less important to outsource production from the developed countries to regions

where labour is cheap? There is talk about a “reserve army of robots” holding down wages in the

poor countries. If this is really the case, it might not be feasible for the least developed countries to

achieve their economic take-off as the Asian countries did on the basis of cheap labour

manufacturing production. This is a very serious worry for Sub-Saharan Africa where they have not

yet been able to take this step.

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Figure 3: Share of Export in GDP 1967-2015

Another major dimension of globalization is foreign direct investment (FDI). Also here there has been

a stagnation of magnitudes in relation to GDP. The peak for FDI relative to world GDP was in 2007,

when it was 5.4% in 2015 it was down to 2.9% after a slight recovery toward the end of the period.

This is also related to the increased caution following the financial crisis. Debt relative to world GDP

increased from 180% in 2007 to 220% in March 2017, so there is probably a need for deleveraging.

The fall in FDI growth may also reflect an increased scepticism against outsourcing production to

poorer and cheaper regions.

So overall it seems fair to say that the process of globalization has slowed up, and if improved

participation in the global economic exchange is important for growth in the poor countries this is a

serious concern.

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Figure 4: FDI as a share of GDP 1977-2015

Trade and FDI involve large flows of resources, but what about other resources flows that may

matter for poor countries such foreign aid. Figure 5 shows that ODA is nowadays of rather limited

magnitudes relative to GDP for developing countries. In most regions the average inflows are less

than one percent of GDP, while it is only 3% of GDP in the most aid dependent region, that is Sub-

Saharan Africa. Clearly these flows cannot compensate to any high degree for the lack of trade

revenues and FDI inflows except in the poorest countries. Remittances are actually a few times larger

than ODA flows. Foreign aid can of course contribute in other ways by transferring knowledge etc.,

even if it is quantitatively less important than earlier also for the poorest countries. The rich

countries may also play a major role by helping to devise a system that makes it possible for the

poorest countries to link up to the world market.

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Figure 5: Aid as share of GDP 1967-2015

4. Northern Backlash

The prospects for poor countries to enter the world markets in a major way thus may be held back by

structural changes in the global economic system. But this is not their only problem. We also have a

situation where there is a backlash against globalisation in the North, which may make poor country

access to the global markets harder.

This increasing scepticism in the West against globalization has several explanations. Although

globalization has improved outcomes on average, there may be groups that have lost out or failed to

gain what they see as their fair share. Globalization may have helped reduce the gaps between rich

and poor countries, but it may at the same time have contributed to increased inequality within

countries. The pattern of income growth that the world has experienced may be illustrated by

Branko Milanovic’s (2016, p. 11) depiction of how global incomes changed by percentile between

1988 and 2008 (Figure 6). The title of the first chapter in the book sums up its main message well –

“The Rise of the Global Middle Class and Global Plutocrats”.

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Figure 6

The diagram shows that there have been major advances for a broad segment of people between the

15th of 65th percentile. These include Asian populations reflecting, for example the rapid growth in

Chinese middle class incomes. Further up in the global income distribution we see that the income

growth has been much less. This group includes for example the US middle class, which has not seen

real wage increases for decades. At the top, however, incomes have grown fast. This is shown by the

estimates of the USA by Alvaredo et al (2016) (Figures 7). This is what has sparked the debate about

the increasing gap vis-a-vis the top 1 percent.

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Figure 7

The development has been similar but less dramatic in France, but even more striking is that it has

been very pronounced in China (Piketty et al., 2016) (Figure 8). The latter is now more unequal than

France.

Figure 8

This change in the pattern of incomes has also had far-reaching implications for the distribution of

wealth (Alvaredo et al, 2016). We see in Figure 9 that a long historical process of reduction of wealth

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concentration in the Western economies was reversed around 1980. At the same time we see that

the pattern repeats itself also in China. The factors that determine the evolution of the wealth

distribution are differences in savings rates across income and wealth groups, differences in labour

incomes and returns to wealth as well as the progressivity of income and wealth taxes (Alvaredo et

al., 2016). Figure 9

It is the increasing inequality in the North, which risks undermining support for the liberal global

order, and generally non-inclusive growth patterns may undermine trust and eventually governance,

undercutting policy-makers’ ability to sustain policies that support high growth (Spence, 2011). At

the same time there does not seem to be a similar backlash in the South. In the North we can now

see an emerging conflict between one group that puts high priority on solidarity or equity within its

own country, and another one that is relatively more concerned about global justice. The former are

more sceptical than the latter against free trade, market liberalism, and liberal migration policies.

The globalization sceptics tend to be “patriotic” or nationalistic and put a higher value on national

citizenship.1

1 President Trump is threatening to scrap NAFTA or make it less open. He wants for example to increase the share of a product that is produced in North America in order to enjoy tariff-free trade between the countries involved (in the case of automobiles and parts from 62.5 % to 85 % and with 50% of the value from the US

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At the same time as there are groups in the West which are concerned about the impact of far-

reaching globalization on them and therefore are backing political forces seeking to roll it back, there

are large groups in developing countries that haven’t had the opportunity to become “globalized”

and therefore have failed to benefit from globalization. De Soto2 argues that there are five billion

people in the world who have failed to effectively participate in the global economy. He argues that

the integration of these people is a key condition for global justice.

So even if we are primarily concerned with global justice and development in the South, we face a

double challenge. If we accept that an efficient lifting of poor people in the developing world out of

poverty depends on their successful integration into the global economy, we face challenges on two

fronts. We need to ensure that the open international system is maintained (and preferably

developed further), but this requires the support of the majority of citizens in the rich countries. To

maintain this support we need to be concerned about inequalities in the North, which tend to lead to

increased anti-globalization attitudes. The second challenge is to seek to make it possible for the

poor in the South to get access to the global system and to benefit from this access. To make it

possible for the poor countries of the world to catch up we need to be concerned with what growing

inequality in the North does to these prospects.

5. Managing Globalization for Development in the South

What are the forces currently driving the transformation of the world economy? A couple of decades

ago the message was that the new information technology had made it easier to coordinate

production activities via the market and that the importance of firm size was declining. Outsourcing

via market transactions was growing rapidly. However, recently it seems as if the trend has been

reversed and that a process of concentration is underway. Antras and Chor (2013)3 analyse this issue

within a property rights model of firms’ boundary choices, i.e. the extent of control over different

segments of the value chain. They explain how firms organize the global value chains and why it now

may be beneficial to do transaction within firm rather than at arms-length distance in the market.

The largest corporation in the North now produce an increasing share of GDP. For example, in 1994

the 100 largest firms of the US produced 33% of its GDP, while their share had increased to 46% in

2013!4 There is a clear process of concentration of control of the global economy, and it is not

itself). He wants to limit the number of federal contracts that Mexico and Canada can win, and wants to change the NAFTA dispute settlement procedures (New York Times, 2017-10-12). 2 Hernando de Soto: “Globalization for everyone”, Project Syndicate September 19, 2016. 3 Antràs, P. and Chor, D. (2013), “Organizing the Global Value Chain”. Econometrica, 81: 2127–2204. 4 ”The rise of the superstars”, Special report in the Economist, September 17, 2016.

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inconceivable that this is matched by an increasing concentration of wealth and incomes. This

concern has been raised by, for example, Piketty.5

It seems clear that globalization has contributed to the increasing income concentration by making it

possible for firms to roll out their business models globally and thereby reap the benefits of

economies of scale. The new global superstars benefit from network economies, which make it

possible to reduce costs per unit or increase monopolistic profits by conquering larger and larger

market shares. The reaping of excess profits and their allocation probably contributes to increased

inequality. The capital share of GDP is on has increased in the North, and Bengtsson and

Waldenström (2015) shows that there is a very high correlation between inequality and the share of

capital in the national income.

Of course, these new giant firms have provided consumers with new and very beneficial gadgets, and

one would like to see them continue to do so. But for this to be possible without a public backlash

there is a need to seek to control them better in terms of, for example, the payment of taxes. At

present some 30% of FDI of global firms flows through tax havens, and they are able to exercise their

power in negotiations with governments about rules and regulations. So to maintain the legitimacy

of the global economic system, the global firms need to be better controlled and the benefits of the

firms needs to be better distributed. For this to be effective there is a need for international

collaboration, since the large firms can circumvent national attempts at controlling and taxing them.

Such international collaboration (OECD is seeking to enhance tax cooperation) would be beneficial

also for the groups in the North who feel left behind. There are, for example, discussions about

source-based taxation, but since the supply chains of today are so complex it is hard to know where

one should apply it.

The idea among globalization sceptics that trade restrictions will help reduce inequality in the North

is problematic. For example, in the US the poor will see a much larger fall in real income than the

rich, due to the high share of imports in their consumption baskets.6 And it is also the case that a

large share of the inequality increase in the US is driven by the increasing concentration of profits.7

The increase in wage inequality is also driven by this, since two thirds of it is explained by increasing

differences between firms in average wage paid (the profitable firms pay more at all levels), while

increased within firms inequality explained only one third.8 Thus, it seems to be the case that the

5 Piketty, T. (2015), Capital in the 21st century, 6 Pablo D. Fajgelbaum, P.D., Khandelwal, A.K. (2016); Measuring the Unequal Gains from Trade”, Quarterly Journal of Economics, 1113-1180. 7 Furman, J., Orszag, P. (2015), A Firm-Level Perspective on the Role of Rents in the Rise in Inequality, Presentation at “A Just Society” Centennial Event in Honor of Joseph Stiglitz, Columbia University 8 Song, J., Price, D. Guvenen, F., Bloom, N., von Wachter, T. (2016), Firming Up Inequality, Stanford mimeo

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higher monopolistic rents earned by larger corporations increase inequality by increasing profits and

increasing wage inequality. The effective way to combat this is not tariffs but rather to deal with the

increase in the market power of the big corporations. Competition agencies have not been effective

in countering the process of concentration. When newcomers enter the market the major players

tend to buy them before they can compete effectively. So competition policy could be an effective

policy measure. There is also a need for an active labour market policy protecting the losers in the

structural changes due to globalization. There should also be macroeconomic measures to keep

demand up but also structural measures such as re-education. And lastly there need to be safety nets

that protect those that cannot come back into the labour market.

An international system that controls the multinationals would of course also be important for the

countries in the South, who suffer from the transfer pricing and negotiation tactics of MNEs. At the

same time the poorer countries need to attract foreign capital and technology to make it possible to

close the gap to the North. The outsourcing revolution has essentially bypassed sub-Saharan Africa

because of its poor institutions and infrastructure and because of its lack of relevant connections to

the international markets. This lack of integration is a serious concern, since much of the transfer of

technology to the South occurs via FDI and outsourcing.

China managed to break into global supply chains on the basis of its cheap labour, and by now it

supplies a fifth of global manufacturing exports. Chinese incomes have increased rapidly and

hundreds of million Chinese have been lifted out of poverty. The question now is whether other

locations with cheap labour such as Sub-Saharan Africa will be able to repeat the Chinese take-off.

The situation seems to be that capital goods and automation are getting cheaper, and therefore it

will be harder for SSA to break into the global supply-chain economy on the basis of its cheap labour.

This is very problematic since about 80 percent of world trade takes place within supply-chains

within multinational corporations or organised by them. There is actually a considerable relocation of

production back to the North from the South.

Most economists support free trade, but there is less unequivocal support for free capital movement.

Clearly poor economies need more investments, and foreign investment is one way of getting it.

Foreign direct investments are generally beneficial, but it is less clear that short-term capital flows

are. There is considerable evidence that surges short-term of short-term capital can cause severe

problems in the form of banking or currency crises.9

9 Ghosh, A., Ostry, J.D., Qureshi, M.S. (2014).Exchange Rate Management and Crisis Susceptibility; A Reassessment, IMF Working Paper 14/11.

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The international system should be designed in such a way that it becomes easier for poor countries

to link up to the world market. At the same time, these countries must get their own economies set

up for global integration. The character of such an economy is fairly well known. What is less well

understood is how one set up the political and institutional system so that an efficient economy can

be developed.

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References

Antràs, P. and Chor, D. (2013), “Organizing the Global Value Chain”. Econometrica, 81:

2127–2204.

Bengtsson, A., Waldenström, D. (2015), Capital Shares and Income Inequality: Evidence

from the long run”, IZA DP No. 9581.

de Soto, H. (2016) : “Globalization for everyone”, Project Syndicate September 19.

Furman, J., Orszag, P. (2015), A Firm-Level Perspective on the Role of Rents in the Rise in

Inequality, Presentation at “A Just Society” Centennial Event in Honor of Joseph Stiglitz,

Columbia University

Ghosh, A., Ostry, J.D., Qureshi, M.S. (2014).Exchange Rate Management and Crisis

Susceptibility; A Reassessment, IMF Working Paper 14/11.

Maddison, A. (2006), The World Economy: A Millennial Perspective, OECD Development Centre, Paris.

Milanovic, B. (2016), Global Inequality: A new approach for the age of globalization, The

Belknap Press of Harvard University Press, Cambridge, Mass.

Milanovic, B., Roemer, J.E. (2016), “Interaction of Global and National Income Inequalities”,

JGD 7(1): 109–115

New York Time (2017-10-12), “Trump’s Tough Talk on NAFTA Suggests Pact’s Demise is

Imminent”.

Pablo D. Fajgelbaum, P.D., Khandelwal, A.K. (2016); Measuring the Unequal Gains from

Trade”, Quarterly Journal of Economics, 1113-1180.

Piketty, T. (2015), Capital in the 21st century,

Song, J., Price, D. Guvenen, F., Bloom, N., von Wachter, T. (2016), Firming Up Inequality,

Stanford mimeo

Spence, M. (2011), The Next Convergence: The Future of Economic Growth in a Multispeed

World, Farrar, Straus and Giroud.

”The rise of the superstars”, Special report in the Economist, September 17, 2016.