A report to be issued this coming week by the IMF (the technical analysis was released early) shows that greater globalization during the past two decades contributed significantly to rising inequality during this period in most developing as well as developed countries. The media greeted this conclusion about the connection between inequality and globalization with claims that the new report is "handing critics of globalization a powerful weapon" and "The report is an unusual admission by the IMF of the downsides of globalization" (Wall Street Journal, October 10, p.9). Yet a careful evaluation of the report's findings on income and inequality provides in most respects an optimistic assessment of the effects of globalization on developing nations.
The report analyzes what happened to incomes and inequality in over 50 countries. It finds that essentially all these countries had large increases in per capita incomes since the early 1980's. While the growth was positive at different income levels, including those at the very bottom, income growth was not uniform among different skills, or at different parts of the income distribution. Incomes grew faster for the more skilled and in higher income quintiles, which implies that various measures of inequality typically increased in developing nations.
To explain these results, the IMF authors divide the effects of greater globalization into expanded world trade, greater foreign investment, and increased transfers of modern technologies. They find that all three dimensions of globalization tended to increase per capita incomes of both developing as well as developed countries. International trade theory implies that trade by a poorer country would increase the relative earnings of its lower skilled workers because richer countries want products from poorer countries that use relatively large quantities of unskilled workers, such as textiles. The report's evidence quite strongly supports this building block of trade theory: greater trade alone would have lowered earnings inequality within developing countries.
However, the most powerful effect on inequality from globalization is due to transfers of modern technologies. The evidence from developed economies has been that modern technologies, like the computer and Internet, favor more educated and other skilled workers; in economic parlance, that these technologies are skill biased. This effect of technological progress has been used to explain the sharply rising gap in earnings between college graduates and others during the past three decades in the United States (see my discussion of inequality in the blog entries for April 23 and December 10, 2006). Not surprisingly, the IMF's study finds that a similar skill bias applies to international technology transfers, that they raised the earnings gap between more skilled and less skilled workers in developing countries. In other words, foreign direct investment has a skill bias too, so that its sharp growth over the past 25 years raised inequality in developing countries. Better capital markets had a similar effect on inequality. However, the evidence in this report indicates that the effects on inequality due to foreign investment and capital market liberalization, while not minor, were much smaller than the effects of technology transfers.
Is this greater gap between the earnings of more and less skilled workers a good or bad result of globalization? Let us accept that greater inequality is not good, other things the same, but other things are different in the IMF results on inequality. The increased earnings gap between persons with more and less education in developing countries reflects that the earnings of more educated individuals rose faster than the earnings of the less educated. The IMF report clearly shows that generally the poorer and less educated in developing nations also became better off in that they have more to spend on food, shelter, health, automobiles, and the other goods that they desire. This improvement in wellbeing at the lower end of the income distribution surely should count as a benefit of globalization.
The larger earnings gap by education essentially means that the returns on investments in schooling increased. Few critics of globalization would claim that its effects were bad if globalization significantly raised the returns to financial or physical capital owned by local investors in developing countries. So how can one complain that globalization is bad because it raises the returns on the education of local human capital investors? Higher returns to human capital investments as well as greater returns to plant and equipment mean that the economy is more productive, which should be a welcome development to poorer as well as richer countries.
Yet intellectuals and politicians in many countries of Latin America, Africa, and even parts of Asia have heavily criticized globalization and its effects. I believe that developing countries in which the criticisms are strongest are generally countries that have done a bad job of educating its population. Higher returns on investments in education and other human capital are small comfort to the children of poor families who often do not have easy access to secondary schools, let alone to universities and other forms of advanced investments in human capital. The lesson of the IMF report and other studies is that globalization is not the source of these serious problems. Rather, the lesson is that many developing countries have to do much more to open up access to better and greater education for children coming from lower income families. Only then would these families be able to take advantage of the higher returns to education produced by greater trade and the inflow into their economies of modern technologies and foreign capital.