Workers in emerging economies benefitted from globalization and workers in rich countries, on balance, did not. Overturning globalization, however, will neither work nor bring a real improvement to the Western middle classes.

The reason why this article on inequality is being published and the reason why you are reading it is because income and wealth inequalities have risen, often dramatically, in most countries in the world over the past 40 years.

This is a well-known fact which is nevertheless worth emphasizing because the United States is often mistakenly singled out, and the impression is created that such increases were small or non-existent everywhere else. While US inequality did rise substantially—from 34 Gini points at the trough of inequality in 1979 to 41 Gini points in 2016((Calculated from Luxembourg Income Study data, based on US Current Population Survey.))—it was hardly unique.((Gini index, a measure of inequality, ranges from the theoretical value of 0 when all individuals have the same income to an equally theoretical value of 100 when the entire income is received by one person. It is considered that relatively equal countries have Ginis around 30.)) Out of seventeen OECD countries for which comparable data are available, fifteen saw an increased inequality in disposable income (that is, income that people receive after social transfers and direct taxes) between the mid-1980s and 2013-15.((See 2015 OECD report: In It Together: Why Less Inequality Benefits All.))

There are some unusual suspects in this group. Israel, which used to be a semi-socialist country, is now as unequal as the United States. Sweden, which some people still see as a paradise of welfare and equality, had the greatest increase of all countries. Denmark, held by Bernie Sanders as the model the United States should emulate, also registered an increase (3 Gini points). Germany, another powerhouse of worker codetermination and collective bargaining, experienced the same increase as Denmark.

And not only did disposable income inequality rise; inequality of market incomes, that is incomes before taxes and transfers, went up by even more. Since market income is composed of wages and property incomes unaffected by direct taxes and social transfers (such as public pensions and welfare), the rise in market income inequality shows that all rich countries were exposed to the same forces of globalization and technological change that tended to push inequality up. At the disposable income level, although inequality went up in all seventeen advanced countries considered here, in some countries it went up less than in others due to differences in economic policy.

A comparison between the United States and Germany is instructive in that regard. The top line in figure 1 shows inequality of market incomes. As can be seen, inequality increased steeply in both countries. Actually, it increased even more steeply in Germany and has recently been at the level of about 55 Gini points in both countries. The bottom line shows what happens to disposable income inequality once social transfers and direct taxes kick in. In both countries, disposable income inequality is less than market income inequality as transfers and taxes help the poor and the middle class.

But the inequality-reducing effect of transfers and taxes is much weaker in the United States. Moreover, until the mid-1990s, their effect was “accommodating” as inequality in both disposable and market incomes went up by about the same amount (shown in parallel upward movements of the two lines in figure 1). In Germany, however, taxes and transfers are more redistributionist, and inequality in disposable income increased significantly less than in market incomes (the bottom line in the figure went up by very little despite the steep rise in the top line).

Why did it happen? In the United States, economic policies until the late 1990s (tax rates, progressiveness of social transfers and the like) remained about the same as they had been when market income inequality was much lower (in the 1970s and 1980s). In other words, policy sometimes accommodated higher inequality rather than offset it. In the case of Germany, policies were deployed to partially curb the rise in market income inequality, and consequently, the bottom line rose much less than the top line.

Figure 1: Market and disposable income inequalities in the Unites States and Germany. Source: Calculated from Luxembourg Income Study (LIS) data. Note: Market income includes income from work and property. Disposable income is equal to market income plus social transfers (pensions, unemployment benefits, etc.) minus direct taxes.

Thus we come to our first conclusion: While all rich countries were exposed to the same forces of globalization and technological change that tended to push inequality up, and while almost all failed to offset these forces fully, there was still a role for policy. In some cases, policies continued as in the past when the underlying forces of inequality (“the winds of globalization”) were much more benign; in others, pro-poor policies were used to offset them. We shall come back to this conclusion regarding the role of domestic policies.

Rises in inequality were not limited to rich countries. China’s inequality at the beginning of Deng Xiaoping’s reforms in the late 1970s was very low; presently, it is higher than inequality in the United States. In other words, if increase in inequality in the United States is found worrying, so much more is the rise of inequality in China.

However, China has one big “attenuating” circumstance: Its inequality doubled while its real income per capita increased by more than 20 times. Obviously, it is much easier to find increases in inequality acceptable when everybody’s income goes up, and especially when it does so at a rate as high as it did in China.

That was not the case in Russia where, during the Yeltsin years, real income plummeted (even more than during the Great Depression in the United States), and yet inequality increased vertiginously. Russia became the country where the total combined wealth of billionaires was, measured in terms of country’s GDP, the highest in the world.((Calculated from Forbes data.)) Such an increase in inequality, combined with a much lower overall real income, meant impoverishment for many.  The humiliation of the many along with huge wealth for the few is what has led to a rejection of the Yeltsin years and an acceptance of Putin’s form of oligarchy. 

In India too, inequality increased after the liberalization reforms of 1991. However, similarly to China, higher inequality was accompanied by higher incomes and was thus socially more bearable. Even, and somewhat incredibly, in post-apartheid South Africa (which at the close of the apartheid era was among the most unequal countries in the world), income inequality increased even further. It is a big political issue, as shown by the weakening power of ANC and the increasing prominence of the extreme left-wing Economic Freedom Fighters.

It is thus not surprising that income inequality had become such an important political issue (Barack Obama called it “the defining issue of our times”). If income differences between people increase, if governments are not seen as able or willing to do much, if many high incomes are the product of monopoly rents or corruption, if the middle class is shrinking, one can hardly be surprised at the political salience of inequality.

But what is, at first sight, paradoxical is that such rising inequalities within nations are accompanied by decreasing global inequality—that is, if we look at inequality across all citizens of the world (more than 7 billion of them) and not merely at inequalities within each nation-state as we have done so far. There, using the same indicator of Gini coefficient, global inequality has gone down from more than 70 points in the mid-1980s to some 65 points today.((Own calculations.)) It is still enormous, but it is lower than it used to be. Even the proverbially immensely rich global top 1 percent has seen its share of global income diminish after the global recession, from 22 percent in 2008 to 20.4 percent in 2013.((World Inequality Report 2018.))

How did it happen? The answer is simple: The reduction in global inequality was driven by high income growth in heretofore very poor countries like China, India, Vietnam, and Indonesia where almost everybody had seen their incomes increase at a fast clip—much faster than in the rich world. Thus a sort of “global middle class” has been created.

Figure 2 shows this phenomenon through the thickening of the distribution around the middle: There are simply more people in the world with incomes that are around the world median. These are indeed not the people that, in Western perception, would be considered a “middle class” since their incomes are much lower than typical Western middle class incomes, but from the global point of view they are indeed a (large) group sitting right in the middle of the global income distribution and, if the trends continue, likely to move upward. The slowdown of growth (and several years of negative growth) that affected the rich West in the wake of the global recession further helped the convergence of Asian incomes and reduced global income inequality.

Figure 2: Global income distribution in 1988 and 2011. Source: Calculated from Lakner-Milanovic World Panel Income Distribution.

Two things are remarkable in the current decline of global income inequality: For the first time in the past 200 years, inequality among world citizens has decreased; and this decrease has taken place while within-national inequalities almost everywhere have gone up. These two facts, translated in terms of winners and losers, mean that workers and the middle classes in emerging economies did well, and workers and the middle classes in the rich world did poorly. Simplifying things a bit, we can say that workers in emerging economies benefitted from globalization and workers in rich countries, on balance, did not. Is there a conflict of interest between the two groups?

The answer is “yes.” And the reason is, I think, obvious. So long as national economies were not fully integrated, and especially so long as several billion workers in China, India, Russia, and elsewhere were not fully part of a global capitalist economy, very different wages for the same kind of labor could be maintained. A French worker was not in direct competition with a Chinese worker. But with globalization, if these two workers produce the same product or have approximately the same skill, they now enter into competition. Whom, if he can choose, is the capitalist going to hire? The answer is obvious: a cheaper worker.

Now, not all workers are in mutual competition: Some are producing so-called non-tradables that cannot be exported or imported (domestic services, legal advice, many medical procedures, etc.), skills of some are complementary to the skills of porer workers (a cheaper Indian accountant would increase the income of a Western self-employed worker), and some are directly competing (Indian and Western accountant, or American and Chinese steelmakers).

What should countries do then? It does not seem that the emerging economies need to do much since, given their wage rates and the type of globalization that exists, things seem to be working to their advantage. This scenario, of course, will not continue forever. As China becomes richer, its wages will rise, and the cost advantage will gradually diminish. We already see the wages of unskilled workers in China rising faster than those of skilled workers, and the gap between Chinese and Western wages is now less than it used to be. But it is also true that China, while the largest country and in that sense the most important competitor of the West, will be followed by other populous and still relatively poor countries like India, Vietnam, Burma, and Ethiopia that could, down the road, present the same competition for Western labor that China does today.

So, the question of what to do poses itself much more forcefully for the rich countries. The knee-jerk answer is to shut down integration and globalization, since those developments are at the origin of the problem. But that intuitive reaction does not take into account that globalization is also at the origin of many income gains in rich countries, that it enables specialization in the areas where countries are more efficient, and that neither slamming of tariffs nor a ban on outsourcing will substantially help domestic workers or overturn the process of globalization that has gone too far. Even the most powerful countries like the United States become “small” when contrasted with the world: It might have been different in the 1950s when US Gross Domestic Product accounted  for 40 percent of the world’s output, but today it is only 16 percent.((Calculated from World Bank data; in Purchasing Power Parity dollars.))

Thus, overturning globalization will neither work nor bring a real improvement to the Western middle classes. What will? Only domestic policies whose objective is either direct compensation of those who have lost their jobs, or (much better) greater efforts in matching  the new workers’ skills to the demand, and especially in improving the quality and accessibility of education for all.  This has been realized to be a problem in the United States where the quality of public education, due to neglect and lack of funds, has deteriorated, and where what used to be probably the best system of public education in the world has slipped much in the rankings (as measured by students’ scores on math and sciences).

There are thus two types of domestic policies that are the remedies for the “ills” of globalization. One is the standard set of redistributionist policies, including higher taxation of the rich and greater benefits for those whose jobs are destroyed. Such policies will allow the bottom line in our figure 1 to remain more or less flat (that is, to register no increase in inequality) even if the underlying inequality (reflected in the top line) continues to go up. They are however merely reactive or palliative policies. The second set of policies that deal with education are more long-term in nature. They will help stop the increase in the top line of figure 1 (market income inequality) by improving skill levels and by better matching the supply and demand of skills. When the increase in the underlying inequality is less, the standard redistributionist policies can be more relaxed too.

But until that happens, both sets of policies should be used: greater direct help for those affected by globalization and longer-term improvements in skills.

For further discussion of inequality and globalization, check out this two-part series by the Capitalisn’t podcast: