Jul 10, 2019 in Economics

Introduction

The degree, to which the world economy is becoming interrelated via the globalization of finance and business, has been unprecedented. The novel trend of globalization has resulted in far-reaching consequences with respect to the economic wellbeing of people in diverse regions across all income categories. In fact, the effects of globalization on the distribution of income is a contentious issue. The debate is usually polarized into two different viewpoints. One viewpoint on globalization is optimistic and maintains that the phenomenon results in a reduction in income inequality. The proponents cite the case of industrial development, whereby even though the early stages of industrialization were characterized by an increase in inequality, in the end, it declined after a county completed its transition towards an industrialized economy. They forecast the same outcome with the case of globalization. On the contrary, others are pessimistic regarding the effects of globalization on income inequality. They maintain that while globalization is likely to improve the overall incomes, the benefits are not distributed in an equal manner among a country’s citizens; thus, are likely to be characterized with clear losers. For globalization to be sustainable, it has to maintain wide-ranging support across the citizens of a nation, which may possibly be affected by the increase in the levels of inequality. Against this milieu, the goal of the current paper is to tackle issue of the effects of globalization on income distribution. The paper argues that the effects of globalization on the distribution of income are not uniform.

Globalization

Globalization generally refers to unrestricted transfer of capital, services and goods across the borders of various nations. Globalization has also been described as a continuous process that has resulted in the spread of western market economies globally. The current level of integration of the global economy has exceeded the peak reached before the World War I. As a result, the novel trend in the global economy has resulted in wide ranging impacts with respect to people’s economic wellbeing in various regions and among the different income groups. The global trend has increased fivefold since 1980. The 1990s saw an accelerated globalization of trade following the integration of Eastern bloc nations into the international trading system. During the same time, developing economies in Asia embarked on eliminating barriers to trade by adopting open trade policies that played an important role in opening their markets to the world. Nevertheless, it is vital to point out that all developing and emerging nations, when aggregated in terms of region or income groups, have been gradually catching up or exceeding high-income nations in terms of their openness to trade. The fact suggests a progress of the trade systems in middle-income and low-income countries towards more open trade regions in advanced economies. Apart from trade, globalization of finance has also occurred at an unexpected rate. The level of financial integration is higher in advanced economies when compared to other regions across the world. The reason is that advanced economies have been progressively increasing their liabilities and assets held overseas. Nonetheless, the measures of openness of capital accounts does not show a consistent picture in the sense that newly industrialized economies in Asia and developing states have a lesser convergence relative to the advanced economies that have embarked on further liberalizations of their finances. It is also worth pointing out that foreign direct investment has increased significantly in all emerging economies. 

 

The globalization wave has been attributed to advancements in information and communication technology as well as transport technology. In addition, the adoption of open trade policies in developing and developed nations has played an important role in accelerating globalization. For instance, numerous nations have adopted policies aimed at lowering the non-tariff and tariff barriers to trade following rounds of negotiations. The 1970s saw many developed countries lifting capital controls, whereas the 1980s was characterized by developing countries adopting open trade policies and liberalization of their economies. Because of such a liberalized environment, firms started expanding their operations to overseas locations in order to bolster their profitability and pursue production factors such as labor. The outcome was an increase in global integration following the introduction of open economic policies, global movement of capital and technological advancements. The benefits and costs of globalization is an issue of hot debate. Majority of international organizations and economists are of the view that globalization plays an important role in spurring economic growth and lessening poverty. However, critics have maintained that globalization insignificantly affects economic growth. Kang-Kook reports that there is no empirical evidence supporting the assertion that financial globalization results in economic growth and cites the negative outcomes linked to the depreciation of foreign exchange rate and financial stability. However, empirical data regarding the positive impacts of international trade on economic growth is stronger although the impact associated with trade liberalization is not obvious. Furthermore, globalization is likely to worsen income inequality through diverse channels such as the volatile transfer of financial capital across countries. The recent financial and economic crisis further raised concerns regarding the effects associated with globalization. Given the tendencies observed in the worldwide trade and the financial environment, there is no doubt that globalization is a reality. 

Effects of Globalization on Income Disparity

Recently, the relationship between globalization and income inequality has been of interest to researchers and scholars. The studies are an indication that inequality and poverty has worsened since the onset of accelerated globalization in the 1980s. In the context of developed nations, the primary concerns regarding the negative impacts associated with capital transfers and international trade on the distribution of income started during the 1980s – a time when the wage disparity widened together with an increase in the skill premium. Several developed nations such as the US reported a significant increase in their Gini coefficients. The phenomenon is somewhat consistent with the propositions of the Hecksher-Ohlin theory, which posits that international trade would reduce the share of workers in advanced economies that have abundant capital goods. Despite the fact that the effects associated with technological progress are relatively larger, the impact of globalization on the distribution of income is likely to be significant owing to the fact that technological advancement might be affected by international competition. As a result, globalization will possibly worsen inequality further with division of production process and the transfer of production to overseas locations through outsourcing. Moreover, the threat impacts linked to factory transfer is likely to weaken the bargaining power of employees. According to Autor, Katz, and Kearney, the neoliberal economic and trade policies, such as regulations aimed at enhancing the flexibility of the labor market and reducing social welfare, have played a role in increasing the levels of inequality. Also, financial globalization is likely to have negative effects on income inequality in developed nations owing to the fact that exporting financial capital has been considered negative related to income distribution.

 

Developing nations have reported increasing levels of poverty and inequality following the onset of accelerated globalization. The fact is not consistent with the suggestions of the simple neoclassical trade theory. It is worth noting that, after the 1980s, inequality in income distribution became a serious problem accompanying globalization. Also, the stagnation of economic growth occurred in a majority of Latin American and African countries. The same trend was reported in transition economies in the course of the 1990s after their sudden adoption of open economic policies. Asia had reported a relatively lower inequality in the distribution of income regardless of the increase in exports; however, the ratios have recently increased following the financial crisis of the 1997. Another Asian economy that has reported a widening of the disparity between the income groups since globalization is China, despite the fact that the country reported significant economic growth after 1980.

 

A number of theories have been developed to explain the increasing inequalities in the distribution of income in developing nations alongside globalization. The first theoretical proposition is that competition for developing nations increased after the 1980s, when nearly all nations commenced participation in the process of globalization. Other theories place emphasis on the differences in terms of initial endowments regarding the trade of intermediate goods as well as global outsourcing. Richer and high skilled workers in developing nations are becoming involved in the production of goods that were initially being manufactured by low skilled workers in developed economies. Consequently, the increase in outsourcing and global trade is expected to make the situation worse for the low-skilled employees in developed nations, although its effect may be opposite for high skilled workers in developing nations. The result is an increase in income inequality in both developed and developing nations. Advancement in foreign direct investments and the import of capital goods in developing economies is also expected to widen the disparity in income distribution because the two aspects are associated with production that requires input from skilled workers. In addition, the governments of developing economies embarked on protecting vulnerable sector of low skilled workers; as a result, economic liberalization and open trade policies are likely to have a negative impact on poor low skill employees.

 

The cross-border transfer of capital and financial globalization might have a negative impact on the distribution of income in developing countries. The liberalization of financial markets in developing nations has been associated with financial instability because of the volatile movements of capital in the short-term. Inequality in income distribution often worsens after periods of financial crises. FDI might be linked to an increase in inequality through a number of channels, including workers being repressed and moving the profits out of the country. Efforts initiated by developing countries to attract foreign investments are likely to lead to worsening of the conditions for the workers because of the “race to the bottom”. In other words, efforts by a country to enhance its attractiveness to foreign investments often comes at a cost. For instance, a country may seek to position itself as a source of cheap labor in order to attract foreign capital. The approach in turn affects workers negatively. Moreover, the decline in fiscal expenditure alongside structural reform resulted in reduced public spending on health and education, which further harms those in low income groups. Deregulating the labor markets along with the neoliberal economic reform resulted in an increase in unemployment and the percentage of irregular workers, which contributes to an increase in wage disparity. The views show the likelihood that globalization will increase the inequality in income distribution in developing and developed countries. However, the impacts of globalization on the distribution of income seem to be conditional because the negative effects are likely to vary in accordance with the absorptive capacity. 

 

Apart from the theoretical explanations, a number of empirical studies have embarked on exploring the relationship between globalization and income inequality. Some studies focus on a single country whereas others compare various evidences. The most common approach is the regression of Gini coefficients as a measure of income inequality against globalization factors like foreign investment, trade, capital account and tariff openness. In fact, majority of empirical studies on the aforementioned coefficients report a complex and conditional relationship.

 

Several researches using single case studies of individual developing nations have reported a simultaneous occurrence of increasing inequality in the distribution of income and globalization. For example, a decline in poverty levels was relatively smaller in areas in India characterized by more open imports when compared to other regions. Inequality in wages and poverty has also been documented to be significantly higher in sectors having lower tariff barriers and a higher demand for skilled workers. Other studies have reported that a higher demand for white-collar employees in sectors of the import of capital goods following the liberalization of trade. In Latin America, foreign investments resulted in a more unequal distribution of income. 

 

Nevertheless, it is also vital to acknowledge opposite results. For instance, the poverty increase in countries with higher levels of globalization measured using foreign investment and export was relatively lower when compared to other regions with lesser levels of globalization. Some studies have also shown that industries with lower tariffs in Poland reported reduced inequality in wages accompanied by an increase in the salaries of non-skilled workers. Numerous studies exploring Latin America nations have reported that the liberalization of the financial markets and the increase in exporting of high-tech commodities worsened the inequality in the distribution of income, although the liberalization of trade did not. In fact, the latter seems to have played a significant role in reducing the inequality in wages in Brazil contrary to other countries of the Latin American region.

 

For the case of developed nations, there is scanty evidence indicating that global trade increased the inequality in wages when compared to the effect associated with technological advancement. Nevertheless, the debate is ongoing because of the difficulties in measuring and that the total globalization effects on income inequality might be greater in reality. Recent empirical studies place emphasis on the wage gap within the same sector because the neoclassical model is incapable of explaining the observation that wage gap increased in the same industry. Thus, both developing and developed nations witnessed an increase in income inequality simultaneously. A study by Meschi and Vivarelli showed that the decrease in costs of global trade has a significant effect on the inequality of wages in organizations in Brazil. As a result, the wage differences reported between firms has been used as an indication that trade can have an impact on wage gap. The wage of workers is comparatively lower in sectors faced with higher levels of globalization measured using import exposure. Nonetheless, Kang-Kook notes that generalizing the causal relationship between inequality and globalization using case studies from a single country is not conclusive. Because of the aforementioned limitation, some studies have performed cross-country studies in an attempt to clarify the effects of globalization on inequality. 

 

Studies that use data from more than one country are more relevant with respect to generalizing the correlation between inequality and globalization. A study has reported that share of the poor 20 percent on world Gross Domestic Product reduced with an increase in open trade policies. In addition, higher volumes of international trade has been reported to increase the wage gap in both developed and developing nations. The correlation is particularly applicable to intra-industry trade that is skill-intensive. Conditional results have also been documented in other studies. For instance, it has been found that the income levels of rich individuals increase more when compared to that of the poor and middle class citizens in developing countries. The outcome results from the increase in foreign investments and trade; however, the effect is opposite for the case of rich and middle income nations. An inference that can be made from the observation is that the effects of globalization in income distribution vary in accordance to the income of nations. When comparing wages and tariffs globally, a decrease in the tariff increases the wage inequality more for the poor nations. Other studies have also reported a positive relationship between trade openness and inequality in income distribution; however, when the economy of the country grows, the inequality reduces. In addition, studies have reported that global trade significantly lessens income inequality in richer developing countries, which can be attributed to the threshold effect, wherein improved human capital and financial and institutional development helps in offsetting the negative impacts associated with globalization.

 

Some studies have placed emphasis on the variations in factor endowments as well as technology when investigating the relationship between international trade and its impacts on income inequality. Thus, some studies have reported that the global trade tends to worsen income gap in nations that rely on mineral resources and have a higher number of skilled workers. Other researches have shown that the liberalization of trade is linked to an increase in wage inequality in nations that have significant number of  skilled laborers and people with low levels of education. It has also been established that engaging in trade with rich countries increases inequality for developing nations, and is particularly evident in the case of middle-income nations. 

 

The effects of foreign investment on inequality have also been explored in literature. Studies with the focus on exploring the link between foreign investment and inequality have reported a positive relationship between the two variables. Foreign investment has been established to increase disparities with respect to the income distribution. A review of most papers suggests heterogeneous and conditional impacts of financial globalization on the distribution of income across various countries. Therefore, foreign investment increases inequality in richer nations with abundant human capital, while it does the opposite for low-income nations. In addition, foreign investment has been established to worsen the distribution of income for nations with low absorptive capacity of infrastructure.

Conclusion

The period after 1980s saw an increase in international trade as well as the liberalization of financial markets globally. At the same time, the income gap has been increasing between the various groups in both developing and developed nations. As a result, there have been concerns regarding the effects of globalization on the inequality in the distribution of income. From the review of the theoretical perspectives and empirical work, it is evident that the relationship between income inequity and globalization is complex and conditional. Therefore, globalization is likely to worsen the distribution of income through diverse channels, which include the increase in outsourcing. Also, foreign investment might intensify income inequality in developed countries. In addition, globalization is likely to result in a bigger gap in income distribution in developing nations through a number of avenues including its harmful impacts on financial stability and variations in endowment. The underlying argument is that impacts of globalization on inequality are not uniform; instead, it depends on diverse conditions. The factors include the country’s absorptive capacity, the share of skilled and non-skilled workers, the industry, income levels of nations, human capital, financial and institutional development in nations, and the state of a country’s economy among others.

 

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