THE THREE WORLDS OF GLOBALIZATION:

MARKET INTEGRATION, ECONOMIC GROWTH AND THE DISTRIBUTION OF INCOME IN HIGH, MIDDLE AND LOW-INCOME

COUNTRIES

Geoffrey Garrett UCLA

February 2004 I would like to thank Nancy Brune for all her help over the years with respect to finding and compiling much of the data used in this paper. Conversations with my colleagues Ed Leamer, Ron Rogowski and George Tsebelis have helped immensely to clarify, and sometimes to change, my thinking about the issues discussed here.

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We've seen the result (of globalization). The spread of sweatshops. The resurgence of child labor, prison and forced labor. Three hundred million more in extreme poverty than 10 years ago. Countries that have lost ground. A boom in busts in which a generation of progress is erased in a month of speculation. Workers everywhere trapped in a competitive race to the bottom. (AFL-CIO President John J. Sweeney at the International Confederation of Free Trade Unions Convention, April 4, 2000)1 … those who protest free trade are no friends of the poor. Those who protest free trade seek to deny them their best hope for escaping poverty. (President George W. Bush, July 18, 2001)2

1. Introduction It is sometimes hard to remember that the debate over economic globalization

dominated world politics from the end of the cold war until September 11, 2001. On one

side stood the pro-globalization “Washington consensus” among the international

economic institutions headquartered there and by the jet setting pilgrims to the World

Economic Forum, “Davos man” according to the Economist.3 Amassed against them

were populist politicians, labor leaders, and myriad non-governmental organizations and

activists who created their own anti-Davis (the World Social Forum) and organized

protests in the streets wherever and whenever the agents of the Washington consensus

met. Anti-globalization protest reached a crescendo in Genoa less than two months before

September 11, 2001. This is how the Guardian introduced its coverage:

As leaders of the G8 group of the world's richest nations began their talks behind their ring of steel, bloody clashes escalated during a day of running battles between 20,000 armed police and tens of thousands of protesters, many of them throwing firebombs and cobblestones dug up from the streets. The scale of the violence dwarfed even the first anti-capitalist confrontation in Seattle 18 months ago.4

1 http://www.aflcio.org/publ/speech2000/sp0404.htm 2 Los Angeles Times, July 18, 20001, page 1. 3 John Williamson, 1993, "Democracy and the 'Washington Consensus". World Development, 21: XX; Economist, February 1, 1997, p. 18. 4 “Day of mayhem forces G8 talks rethink”, The Guardian, July 21, 2001.

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The Genoa protests, like those in Seattle and elsewhere, revolved around one

central issue: the distribution of the costs and benefits of globalization. According to the

boosters, the international integration of markets (the economic face of globalization) is

not only good for international business; it is also the best way to enrich and empower

poor people and poor countries. Not so, retort the critics. For them, globalization lines the

pockets of the global elite at the expense of labor, developing countries and the planet.

The tsunami of September 11 pushed the globalization debate off the front pages.

But the war on terrorism has by no means rendered it irrelevant. Islamic extremists share

the protesters’ revulsion of the western elite and “its globalization”. Looking forward,

few deny that reducing global inequalities would help reduce the deprivation and despair

that are fertile terrain for terrorist recruiters. President Bush made this connection clear –

as well as his belief that more globalization is the solution to it – on the first anniversary

of the terrorist attacks:

Poverty does not transform poor people into terrorists and murderers. Yet poverty, corruption and repression are a toxic combination in many societies, leading to weak governments that are unable to enforce order or patrol their borders and are vulnerable to terrorist networks and drug cartels. America is confronting global poverty. Free trade and free markets have proved their ability to lift whole societies out of poverty — so the United States is working with the entire global trading community to build a world that trades in freedom and therefore grows in prosperity. 5

Is “a world that trades in freedom” really one that also “grows in prosperity”? The

World Bank recently issued a major report claiming to prove once and for all that

globalization has been good for poor countries and for poor people in them.6 The

5 President George W. Bush, “Securing Freedom’s Triumph”, New York Times, September 11, 2002. 6 World Bank, Globalization, Growth, and Poverty: Building an Inclusive World Economy”, Oxford University Press, New York, 2002.

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Economist, Financial Times and Wall Street Journal all seized on this report as

demonstrating just how misguided globalization’s critics are. Martin Wolf of the

Financial Times went so far as to label “the big lie” the notion that market integration

increases inequality.7 But influential academic critics on the left, including Harvard’s

Dani Rodrik and Robert Wade from the London School of Economics, quickly sought to

discredit the World Bank’s conclusions with charges that its analyses are fatally flawed.8

This kind of pitched analytic battle certainly doesn’t help mitigate the clashes of

ideology and self-interest that pervade the globalization debate. But there is a good

reason for it: the analytical challenges associated with isolating the real causal effects of

international economic integration on inequality around the world are immense. The goal

of this article is two-fold. First, I wish to clear the underbrush to make clear what the real

issues are. Second, I provide my own simple take on what has been going on, which I

hope will lead others to do more work to see if I am right.

My empirical focus is on the 1980s and 1990s, the first two decades of the current

global epoch. I begin by dividing “global inequality” into its two separable components –

inequality among countries (differences in national incomes per capita) and inequality

within countries (the distribution of income among a country’s population). I then assay

the international integration of both goods and services markets (i.e. trade) and capital

markets, and then finally assess the connections between globalization and inequality.

I argue that globalization must be understood as a process of change over time –

the increasing exposure of national economies to international pressures – rather than the

7 Martin Wolf, “The big lie of global inequality”, Financial Times, February 8, 2000. 8 Dani Rodrik, “Comments on ‘Trade, Growth and Poverty’ by D. Dollar and A. Kraay”, http://ksghome.harvard.edu/~.drodrik.academic.ksg/Rodrik%20on%20Dollar-Kraay.PDF. Robert Hunter Wade, “The Disturbing Rise in Inequality: Is it all a “Big Lie’?”, in Taming Globalization, David Held (ed.), forthcoming Polity Press.

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level of national exposure (much of which is the project of deep historical forces and

geography that have nothing to do with globalization as it is conventionally understood).

I also contend that globalization and its effects should be undertaken at the national level,

and in terms of changes in government policy towards trade and capital movements

(rather than the magnitude of these international economic flows themselves).9

Focusing on the experiences of different countries is critical because there have

been profound variations in market integration among nations that the oft-cited broad

global trends (“more markets”) obscure.

With respect to measuring the extent of national integration into global markets,

trade and capital are inexorably drawn to economies that are booming. It may also be true

that openness to international markets independently stimulates national economies, but

causality cannot be inferred from the correlation between international economic flows

and economic growth. Using the liberalization of foreign economic policies to measure

globalization mitigates this problem of causal inference as well as isolating the primary

tools at the disposal of policy makers to influence economic globalization.

The remainder of this article is divided into five principal sections. The next

section draws on the experiences of three countries – Argentina, India and Ireland – as a

guide to what I consider to be the three distinct worlds of economic globalization

Sections 3 and 4 then step back to take a closer look at measures of inequality and

international economic integration, respectively. Section 5 moves on to exploit variations

in globalization at the level of individual countries in an attempt to isolate its causal

impact on economic growth and the distribution of income. I then return by way of

9 Dollar and Kraay also make this move, though the way I measure changes in market integration is different from theirs. See. Dollar, D. and A. Kraay. 2001. Trade, Growth and Poverty, World Bank.

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conclusion in Section 6 to the implications of this article for the policy and political

issues that continue to swirl around globalization.

2. Three worlds of globalization Standard economic theory has a lot to say about the effects of international

economic integration. Since Adam Smith at least, it has been an article of faith that

openness to the international economy is good for national economic growth. Ricardo’s

notion of “comparative advantage” still provides the basic rationale: openness allows

countries to specialize in (and then to export) their comparative advantage while

importing products in which they are disadvantaged. 10 Other arguments have been added

to the equation over time, such as the importance of openness to realizing scale

economies. But these only reinforce the mantra that openness is good.

Globalization should be particularly beneficial to developing countries. Poorer

countries should always be “catching up” up to richer ones – because it is easier to

borrow technology than to invent it and because labor tends to be more productive (lower

costs per unit of production) in poorer countries.11 Openness to trade and international

capital should accelerate the catch up process by exposing developing countries to all the

know how of the developed world (not only technology but also less tangible things such

as management skills), as well as ensuring that markets and investment are available to

support what the developing world can produce. Economists also believe that open

markets impose beneficial disciplines on governments in countries where political

10 The state of the art in economics is Frankel, Jeffrey and David Romer. 1999. Does Trade cause Growth? American Economic Review, 89, 379-399. 11 Take the classic case of steel. Britain invented the steel industry during the industrial revolution. In the early part of the 20th century, the US became the world’s dominant steel producer because it could make better steel at a lower cost (borrowing and updating the basic British technology), attracting investment from Britain and elsewhere, and then selling it back to Europe. But then Japan replaced the US in the 1960s, only to lose out to South Korea, which is now seriously under threat from Chinese steel producers.

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accountability is limited – reinforcing the notion that the gains from openness should be

larger in less developed countries. In sum, globalization should result in the cross-

national convergence of incomes, thereby reducing the gap between the rich and poor

nations.

Turning to the issue of inequality within countries, the canonical Heckscher-

Ohlin-Samuelson “factors” model implies very different distributive effects of

globalization in the developed versus developing worlds. Openness should increase

inequality in countries where capital and skilled labor are relatively abundant. But it

should have the opposite effect (reducing inequality) where less-skilled labor is relatively

more plentiful. The intuition is simple. With fewer barriers to international flows of

goods, services and capital, wages will rise in sectors in which a country has a

comparative advantage – but fall in those where it is disadvantaged. Higher income

countries tend to be comparatively advantaged in capital and skilled labor, whereas lower

income countries are relatively more abundant in less skilled labor. Globalization should

thus increase inequality in richer countries (with fewer economic opportunities for the

less skilled) but reduce it in poorer ones (empowering workers with limited skills).

Are the expectations of economic theory borne out in the recent experiences of

different countries? As I have already indicated, this is not an easy question to answer

and I spend the bulk of this article working through the issues. For now, I want to

anticipate the results of my analysis with a brief discussion of three countries – India,

Ireland, and Argentina – that reflect the different ways in which globalization has

affected national economic growth and the distribution of income.

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India and the low income world India in the early 1980s (at the beginning of the globalization process) was a very

large, very closed and very poor country with a moderate level (in cross national terms)

of inequality in the distribution of income among its population. The basic information is

presented in panel A of Table 1, with the numerical data on the left-hand side of the

columns and global ranking (among all countries for which the data are available) on the

right-hand side. I discuss later the sources and methods used in compiling these data.

Table 1. A tale of three countries

A. 1980-1984

India

(Low income) Ireland

(High income) Argentina

(Middle income) International economic flows

Trade (% GDP) 15.4 (142/145) 104.8 (34/145) 13.8 (143/145)

Capital flows (%GDP) 0.3 (134/134) 13.5 (25/134) 12.9 (27/134)

Foreign economic policy

Average tariff rate (1986-1990)

93.5 (1/113) 8.7 (90=/113) 24.6 (41/113)

Capital account openness (0=closed; 9=open)

0 (51=/145) 0 (51=/145) 1.4 (40/145)

National economic performance

Per capita income (1995 $US)

$241 (138/150) $11,193 (29/150) $7,137 (37/150)

Inequality (Gini scores, 0-100) (higher scores=more unequal)

40.0 (40/111) 32.8 (88/111) 40.5 (37/111)

By the turn of the new millennium, India’s economy was much more exposed to

international markets (see panel B of Table 1). Its rates of growth in trade and capital

flows from the early 1980s to the late 1990s were among the fastest in the world, as was

the magnitude of India’s tariff cuts. However, India’s policy towards its capital account

remained constant over the two decades – complete closure on IMF definitions. Per

capita income increased by almost 75% in real terms during the 1980s and 1990s –

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placing India in the top one sixth of growth performers around the world. At the same

time, income inequality decreased marginally – again placing India’s performance well

within the top sixth globally.

Though there are obviously important variations in the recent histories of the

different “low-income” countries, India’s experiences are representative of the overall

effects of globalization in the world’s poorest nations.12 India’s government chose

dramatically to cut tariffs but to maintain tight control on capital account transactions.13 It

seems that this combination of foreign-economic policies was the best incubator for rapid

economic growth in low-income countries. In contrast, low income countries that

maintained or even increased tariffs (such as Madagascar) or that radically opened their

capital accounts (such as Zambia) fared much less well (as I show later in the article).

B. Change by 1996-2000

India

Ireland

Argentina

Change in International economic flows

Growth in trade 73.8% (15/134) 46.5% (29/134) 62.3% (16/134)

Growth in capital flows 1218.9% (5/114) 1144.4% (7/114) 3.3% (91/114)

Change in Foreign economic policy

Reduction in tariffs 63.7% (13/100) 29.6% (51=/100) 52.2% (26/100)

Increase in capital account openness

0.0% (81=/144) 800.0% (1=/144) 200.0% (28/144)

Change in National economic performance

Growth in GDP per capita

78.0% (23/149) 109.6% (9/149) 13.3% (84/149)

Decrease in Inequality (to 1994-1998)

1.9% (11/79) -7.7% (52/79) -6.8% (42/79)

12 Per the World Bank’s widely used definition, low income was defined as the bottom 30% of nations in terms of per capita income in 1980s, with countries concentrated in Sub-Saharan Africa but also including some other Asian nations, notably China. 13 This did not stop cross-border capital flows from growing very rapidly, but India’s government was able to exercise considerable control over them.

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The experiences of India and other low-income countries in the past two decades

accord with the basic thrust of economic theory with respect to trade – tariff reductions

have been good for growth without exacerbating, and probably somewhat mitigating,

inequality in the distribution of national income. But the story on cross-border capital

flows is very different. Even the IMF these days has retreated from advocating capital

account liberalization in developing countries. As the 1980s and 1990s amply

demonstrated, financial liberalization in the absence of the kind of developed domestic

capital markets and prudential regulations that only exist in the advanced industrial

democracies is a recipe for volatility, unpredictability, and boom and bust cycles in

capital flows.14 India’s choice of tariff – but not capital account – liberalization was thus

a very wise one.

Ireland and the high income world Ireland’s experiences capture well the effects of globalization in the developed

(high-income) world.15 Even in the early 1980s, Ireland’s international economic flows

put it in the top 20% of countries around the world – not surprising for a small and

relatively affluent nation. Membership in the European Union meant that Ireland had the

same tariffs as other member states, which were low by international standards

(notwithstanding the EU’s infamous non-tariff barriers to trade, particularly for

agriculture). In contrast, Ireland’s capital account was completely closed on IMF

14 Fischer, Stanley. 1999. Capital account liberalization and the role of the IMF. In Should the IMF pursue capital account convertibility? Essays in International Finance 207, 55-65. (Princeton, NJ: Department of Economic, Princeton University). 15 The high-income category comprised the top 30% of countries in terms of per capita income in 1980. Thus the group included countries such as the wealthy oil exporters from the Middle East in addition to the familiar OECD nations.

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definitions, which was also not unusual for European nations in the early 1980s. Income

inequality within Ireland was low by global standards, again quite common in Western

Europe.

Trade and particularly capital flows mushroomed in Ireland between the early

1980s and the late 1990s. Largely as a result of Ireland and the other EU countries cut

their tariffs (on products from outside the EU) by about one-third over the two decades in

the context of the Uruguay round of the GATT (now WTO), not nearly as much as India,

for example, but from a base of much lower tariffs in the early 1980s. Ireland also

dramatically opened its capital accounts in the 1990s run up to the adoption of the Euro –

with the increase in openness as great as in any other country in the world. Irish GDP per

capita more than doubled from the early 1980s to the late 1990s, about the fastest rate of

growth among the established democracies and among the fastest around the globe. At

the same time, however, income inequality within Ireland increased by almost 8%,

putting it in the bottom two-fights of countries worldwide.

The Irish story is a familiar one in the developing world, and one that is wholly

consistent with economic theory. Trade and capital market liberalization have stimulated

economic growth by fueling the knowledge economy (not only in services and capital

markets, but also with respect to high value-added manufactures). But they have also

increased inequality by exposing less skilled workers (who cannot readily find jobs in the

knowledge economy) to the rigors of competition with low-wage economies. Wealthy

countries that have not liberalized their economies as much – most notably the wealthy

but largely non-democratic oil producing nations of the Middle East led by Saudi Arabia,

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but France and Germany also fit in this category – have not grown at the same rate as the

liberalizers, though they have also experienced smaller increases in income inequality.

Argentina and globalization’s missing middle The effects of globalization in Argentina are indicative of what has happened in

“middle income” countries (the 45% of countries with per capita incomes between the

low and high-income cutoffs, mostly in Latin America, East Asia and the post-communist

states). Trade as a portion of GDP was lower in Argentina than in almost every other

country in the world in the early 1980s, but international capital flows into and out of the

country were relatively large. In terms of foreign economic policies, Argentina ranked

about 40th in the world in terms of tariffs and capital account openness. Its per capita

income placed it near the top of the middle-income category, whereas income inequality

in Argentina was moderate by global standards.

Argentina enacted sweeping liberalization reforms during the 1980s and 1990s,

placing it in the top quarter of liberalizers around the whole world with respect both to

tariff reductions and to the removal of restrictions on capital account transactions. From

their very low base, Argentina’s trade increased rapidly, but there was virtually no

growth in international capital flows from the early 1980s to the late 1990s. Over the two

decades, per capita income increased by a paltry 13% in real terms, while income

inequality within Argentina increased by 7%. On both measures of national economic

performance, Argentina was in the bottom half of countries around the world.

Other middle-income countries that liberalized in the manner of Argentina also

struggled in terms of stagnant growth and rising inequality. Mexico, Brazil and several

other Latin American economies that liberalized with the encouragement (if not

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economic coercion, some would say) of the US and the international financial institutions

also fit the pattern. In contrast, countries where the pace of trade and capital liberalization

was much slower tended to perform better. South Korea is an exemplar. Its growth

miracle continued to rely not only on the export promotion emphasized by the

development agencies, but also on significant restrictions on imports and capital inflows.

Chile was Latin America’s star performer in the 1980s and 1990s. The fact that Chilean

governments imposed significant restrictions on short-term capital flows is well known.

But it must also be pointed out that the country’s tariff reductions mostly took place in

the 1970s, not the last two decades.

It is not too hard to explain why capital account liberalization was considerably

less successful in Argentina than in Ireland. As most policymakers and analysts now

agree, capital account liberalization works best in countries with sophisticated domestic

capital markets and supporting institutions that make contracts enforceable – that is, those

found in the rich industrial democracies. The threshold for effective capital account

liberalization certainly still does not extend down into low-income countries. But the

Argentinean case, like others in Latin America, suggests that capital account

liberalization is also quite risky in middle-income countries.

Why would trade liberalization have been less successful in Argentina than in

both India and Ireland – not with respect to failing to generate more trade, which it did,

but rather in terms of not stimulating GDP per capita income growth (while also

increasing income inequality within the country)? One plausible answer is that the

middle-income countries are neither fish nor fowl in the global economy. They cannot

compete with China and India because their labor costs are too high for production

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profiles that are increasingly similar (concentrated on standardized manufactures). And if

they try to compete in these markets they can only do so by cutting workers’ wages. But

neither can the middle-income countries compete with the US and other developed

nations in the knowledge economy that requires sophisticated technology, strong rule of

law institutions, and highly educated workers. Teching-up rather than dumbing-down is

potentially a more attractive solution for middle-income countries, but it will require

massive investments in infrastructure (communication and technology, transport,

financial and legal institutions, education) that currently seem beyond both the economic

means and the political will of these countries.

In sum, the examples of India, Ireland and Argentina suggest that there three

distinct worlds of economic globalization. These three worlds obviously do not match

either of the dueling stereotypes that characterize much of the contemporary debate. But

there are good reasons for believing that they accurately describe what has transpired

around the world in the past couple of decades. The remainder of this article tries to make

the case in more depth.

3. Inequality: among and within countries Critics of globalization decry the coupling of crippling poverty in the developing

world and manufacturing job losses in industrial countries with the proliferation of

Silicon Valley and Wall Street billionaires. The analytic logic behind these laments

comprises two distinct elements – the perception of growing gaps in per capita incomes

between rich and poor countries and the notion of increasing divides between rich and

poor people within countries. It is possible to combine them into a single index of global

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inequality (see Milanovic 1999), but I think it is preferable to analyze the two faces of

global inequality separately because the dynamics affecting them are quite different.

National economic growth trajectories National income per capita is the conventional way to capture the level of

material well being in a country.16 The simplest way to compare per capita income across

countries is to convert them into a common currency (usually the US dollar) using the

exchange rates at which different currencies are traded (freely in foreign exchange

markets or at official rates managed by governments). If average annual per capita

income in the US was $30,000 and 25,000 naira (the local currency) in Nigeria, and if the

naira-dollar exchange rate was 100:1, then we could express Nigerian per capita income

as 25,000/100 = $250 (these numbers are reasonably close to current reality). On the

basis of this calculation we would conclude that the average Nigerian is 120 times poorer

(in terms of annual income) than the average American.17 Put differently, if the average

Nigerian resident wanted to import from the US an entry level Lexus it would cost about

120 times her annual income.

But the average Nigerian probably doesn’t spend much time considering the

merits of importing luxury cars. Consumption patterns in the US and Nigeria are

obviously completely different. But even when residents of the two countries do consume

the same products, their prices in terms of traded exchange rates tend to be different –

and, in fact, much lower in Nigeria. For example, let us assume that the average Nigerian

16 Life expectancy, education, health and other aspects of quality of life (human rights, the environment, etc) also matter, and they can be quantified (see for example, the UNDP’s Human Development Index). For the purposes of this article, however, disputes over what “development” entails can be overlooked because almost any indicator of development you care to choose ends up being highly correlated with per capita income. 17 The disparity would be even greater if we tried to measure wealth (i.e. including the value of assets that don’t generate income such as owner-occupied homes), but these data are much harder to get.

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and American in fact both buy radios at home. The same radio that costs $20 in the US

sells in Nigeria for 1,000 naira (or $10 at the traded exchange rates). The purchasing

power of the naira in Nigeria is thus twice as great as its traded exchange rate implies. On

this measure, this average Nigerian’s per capita income is now “only” 60 times lower

than the average American’s.

This is a “purchasing power parity” (PPP) comparison – adjusting per capita

incomes according to the prices of the same “basket of goods and services” in different

countries.18 Traded exchange rates, in theory, should converge on those adjusted by PPP

(according to the “law of one price” in a global market). But in practice, traded exchange

rates consistently “undervalue” the currencies of developing countries. Indeed, according

to the World Bank, traded exchange rates in 2000 were half or less PPP exchange rates in

over 100 developing countries – either because markets systematically undervalue

developing country currencies or because their governments hold down official exchange

rates.19

The notion that developing country currencies are chronically undervalued (in

PPP terms) has dramatic implications for how much inter-country inequality one sees in

the world.20 Table 2 presents data for the whole developing world (countries classified by

the World Bank as “low income” and “middle income” in 1980) and for the developed

18 It is not easy, however, to get a meaningful common basket of goods and services. The Economist has had at least some part of its collective tongue in its anonymous cheek when it has published in recent years its “Big Mac index” – comparing prices for the hamburgers around the world. But there is an important principle behind this PPP index. The basket of goods and services used in PPP corrections really should be common the world over, and few products are more widespread and standardized than McDonald’s signature dish. 19 World Bank Development Indicators CD Rom 2003. 20 For a good survey, see Sutcliffe, Bob. 2003. “A more or less unequal world? World Income Distribution in the 20th Century,” Political Economy Research Institute, University of Massachusetts.

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countries (“high income”), at two points in time – 1980-1982 (at the beginning of the

contemporary epoch of globalization) and 1998-2000 (its zenith so far).21

Using traded exchange rates, average per capita incomes in the developed world

were fully 20 times as great as those in the developing countries in the early 1980s.22

With the World Bank’s PPP adjustment, however, the developed/developing country

ratio was 6.6.

Table 2. Per capita incomes in developed and developing countries23

A. Traded exchange rates (constant 1995 US$) 1980-1982 1998-2000Developed countries $20,101 $29,278 Developing countries $1,000 $1,314

Ratio 20.1 22.3 B. PPP exchange rates (current international $) 1980-1982 1998-2000Developed countries $11,008 $26,108 Developing countries $1,665 $3,742

Ratio 6.6 7.0

Real (i.e. inflation adjusted) incomes grew by almost 50% in the developed

countries from the early 1980s to the late 1990s, but only a little over 30% in the

developing world. As a result the ratio of developed to developing country per capita

incomes increased from 20.1 to 22.3 according to traded exchange rates. Using PPP

exchange rates, the ratio increased from 6.6 to 7.0. The differences in the increases in

these ratios are obviously much smaller than the differences in their levels. 21 The country groupings are based on the World Bank’s methodology applied to 1980. The groups were: low income $660 or less in 1980 $US (the bottom 30% of countries); middle-income between $661- $5,090 (45% of countries); and, high-income of $5,091 or more (the top 25% of countries). Throughout this article, I try to use 1980-1982 and 1998-2000 averages as the comparison points in time when the units are large aggregations of countries, but I rely on longer averages (1980-1984 and 1996-2000) when individual countries are analyzed to avoid over emphasis of idiosyncratic years in different nations. 22 Note that calculations weight growth rates in different countries according to their populations. 23 Except where otherwise noted, all the data used in this paper come from the World Bank’s World Development Indicators 2002 cd-rom.

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Whichever type of exchange rates you use, the picture looks even grimmer for the

developing world when the impact of China and India – which together comprise fully

one-third of humanity – is taken into account. China’s economy grew faster than any

other country’s during the 1980s and 1990s, with per capita incomes increasing by more

than 330% between 1980-1982 and 1998-2000 in terms of constant US dollars (using

traded exchange rates). India also grew considerably faster than the developing world as a

whole, particularly in the 1990s.

Table 3 demonstrates the stark differences between these two giants and the rest

of the developing world. If China and India are excluded from the equation, the ratio of

per capita income in the developed world relative to the remainder of the developing

world (when measured using traded exchange rates) grew from 12.0 in 1980-1982 to 15.7

in 1998-2000 – an increase in developed-developing country inequality of 31%, almost

three times as much growth in inequality as was portrayed in Table 1 for all the

developing countries. The story is much the same using PPP exchange rates, though the

developed-developing (excluding China and India) world ratio increased slightly more in

percentage terms (from 4.3 to 6.1, or 41%) than was the case using traded exchange rates.

Table 3. The impact of China and India on per capita incomes

1980-1982 1998-2000 A. Official exchange rates (constant $US) China 177 773 India 234 446 All other developing countries 1,674 1,860

Ratio to developed countries 12.0 15.7 B. PPP exchange rates (current $US) China 512 3,658 India 722 2,239 All other developing countries 2,564 4,309

Ratio to developed countries 4.3 6.1

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So there are really two stories about growth trajectories in the developing world.

On the one hand, the world’s two largest countries boomed in the 1980s and 1990s. Per

capita incomes did not increase nearly so quickly in the rest of the developing world

(only 11% in real terms), resulting in sharp increases in the developing/developed

country ratios (excluding China and Inida). The picture is basically story is basically the

same whether one uses traded exchange rates or PPP adjusted measures (I use traded

exchange rates in the remainder of this article because of serious disputes about the

accuracy of different PPP estimates).24

The distribution of income within countries For many critics the growing income gap between the developed world and most

developing countries matters less than the fates of individuals in different countries. How

many people around the world live in poverty? Is this number increasing or declining?

Measuring poverty is more art than science. The official 2003 poverty line in the US for

an individual was $8,980.25 On this definition, most of the world would live in poverty

(even if one adjusted the US figure for PPP). In the development community, however,

the poverty threshold is conventionally much lower – living on “a dollar a day”.

The World Bank now presents the data using $1.08 per day (a dollar a day,

measured in PPP terms, and adjusted for inflation in recent years, see Table 4). The

World Bank’s bottom line is clear. Yes, a lot of the world’s population (over a billion

24 For discussions of the issues involved in PPP vs market based measures, see Reddy, Sanjay and Thomas Pogge. 2003. “How NOT to Count the Poor.” Columbia University. http://www.columbia.edu/~sr793/count.pdf.; Dowrick, Steve and Muhammad Akmal. 2003. “Contradictory trends in global income inequality: a tale of two biases.”http://www.wider.unu.edu/conference/conference-2003-2/conference%202003-2-papers/papers-pdf/Dowrick%20and%20Akmal%20150503.pdf”, and Deaton, Angus. “Counting the world’s poor: problems and possible solutions”, The World Bank Research Observer, 16 (2), 2001, 125-47. 25 This is according to the Department of Health and Human Services, (http://aspe.hhs.gov/poverty/03poverty.htm.

19

people) continues to live in poverty. But there is also good news: poverty declined

appreciably during the 1990s.26

This headline statistic of poverty reduction, however, belies enormous regional

variations. Simply excluding China from the calculation, for example, halves the

estimated amount of poverty reduction. More people in South Asia lived in poverty in

1990 than was the case in China, and given that India’s growth rate in the 1990s was

among the fastest in the world, the amount of poverty reduction outside these two

countries would have been considerably less than even this diminished figure. We should

probably therefore not be too quick to conclude that the world has poverty beaten.

Table 4. Global poverty

Region 1990 2000 Poverty reduction 1990-2000

East Asia 29.4% (470.1m) 14.5% (261.4m) 50.7%

(excl. China) 24.1% (109.5m) 10.6% (57.0m) 56.0%

China 31.5% (360.6m) 16.1% (204.4m) 48.9%

East Europe & Central Asia

1.4% (6.3m) 4.2% (19.9m) -200.0%

Latin America & the Caribbean

11.0% (48.4m) 10.8% (55.6m) 1.8%

Middle East & North Africa

2.1% (5.1m) 2.8% (8.2m) -33.3%

South Asia 41.5% (466.5m) 31.9% (432.1m) 23.1%

Sub-Saharan Africa

47.4% (241.0m) 49.0% (322.9m) -3.4%

Total 28.3% (1237.3m) 21.6% (1100.2m)23.7%

(excl. China) 27.2% (876.7m) 23.3% (895.8m) 14.3%

Source: http://www.worldbank.org/research/povmonitor/

26 The World Bank’s findings are reflected in other studies as well, such as Sutcliffe (2003) and Dikhanov,Yuri and Michael Ward. 2003. “Evolution of the Global Distribution of Income.” http://www.warwick.ac.uk/fac/soc/CSGR/PDikhanov.pdf

20

But there is another reason not to focus too much on poverty statistics. Changes in

poverty rates are affected by two distinct phenomena: how quickly a country or region is

growing; and, how the fruits of this economic growth are distributed among different

people. I have already discussed differences in the growth trajectories among countries,

and the China case shows how much this can affect poverty rates.

Inequality within countries (for any level of national per capita income) is a

different matter. The basic phenomenon one wishes to measure is how widely a country’s

national income is shared. Complete equality would be manifest if every person earned

the same amount of money; complete inequality would obtain if a single person held all

national income. There is a statistic that captures this distinction, and every graduation of

inequality between these two hypothetical extremes – the Gini coefficient ranging from 0

(complete equality) to 100 (complete inequality). The effective range for national Gini

coefficients today is between 30 and 50.

A lot is known about the distribution of income in some countries, including the

United States. But for most of the world, getting even the most rudimentary data is a real

challenge. The best way to find out about individuals’ incomes is to ask them questions,

in surveys, censuses etc. Leaving aside issues of privacy and the reliability of answers,

the sheer logistical hurdles to doing scientifically acceptable surveys are immense, and

geometrically more so in the developing world.

The most widely used data set on within-country inequality is the World Income

Inequality Database (WIID), building on the foundational work of Deininger and Squire

at the World Bank.27 Panel A of Table 5 presents income inequality data for developed

27 Deininger, Klaus and Lyn Squire (1996). A new data set measuring income inequality. World Bank Economic Review, 10(3), September, 565-91.

21

and developing countries and for the whole world (based on un-weighted national data),

only using data WIID deems of acceptable quality. According to WIID, within-country

inequality for the world as a whole decreased slightly from the early 1980s to the late

1990s (from a Gini coefficient of 34.7 to one of 33.8 (a 2.8% decline). However, this

global figure coupled a slight increase in inequality in the developed world (from a lower

base) with a somewhat larger decrease (on a higher base) in the developing world. On

these data, even though the gap in per capita incomes between most developing countries

and the developed world widened in recent decades, at least the distribution of income

within developing countries became a little more equitable.

Table 5. Gini coefficients of within-country inequality

A. WIID 1980-1982 1996-1998 % change World 34.7 33.8 -2.8% Developed countries 34.5 35.0 1.4% Developing countries 34.8 33.4 -4.1% B. UTIP 1980-1982 1996-1998 % change World 36.6 38.4 5.1% Developed countries 32.3 35.0 8.4% Developing countries 38.4 40.0 4.3%

WIID data from http://www.wider.unu.edu/wiid/wiid.htm; UTIP data from http://utip.gov.utexas.edu/.

WIID suffers, however, from two important limitations: its estimates of inequality

mix apples and oranges, with some pears thrown in as well; and, its data are scarce for

the developing world.28 It is thus not surprising that others have tried to do better. The

most recent data set to emerge is from the University of Texas Inequality Project (UTIP).

UTIP uses industrial surveys of wages in the manufacturing sector conducted by the UN

28 Some surveys used in WIID were based on incomes people received, others on expenditures people made. Some surveys were for households, others for individuals. Some report gross incomes, some net incomes (after taxes and government transfers). The authors of WIID themselves acknowledge that these differences have substantial effects on their own estimates of inequality.

22

Industrial Development Organization (UNIDO) to derive wage inequality measures. The

good news with the UNIDO data is that they are plentiful.29 The bad news is that not

everyone is employed in the manufacturing sector (with services dominant in developed

countries and agriculture dominant in developing countries). UTIP deals with this

problem by adjusting its scores in accordance with the observed relationship between

UNIDO industrial pay data and WIID income inequality data (where both measures

exist).30 The results of this exercise are displayed in panel B of Table 5.

According to UTIP, average inequality for the whole world was not only higher

than WIID estimates; it also increased, rather than decreased, during the 1980s and

1990s.31 UTIP’s Gini coefficient for the developed countries was lower than that reported

by WIID for the early 1980s, whereas its measure of within-country inequality in the

developing world was higher. UTIP also estimates that inequality had increased in both

developing and developed countries by the late 1990s, in contrast with WIID’s more

optimistic conclusion.

Whose estimates should we believe? UTIP authors have gone to great lengths to

try to convince skeptics that their numbers are better. Supporters of WIID, including the

World Bank, counter that no amount of statistical correction can make up for the fact that

manufacturing pay represents only a fraction of national income.

My reaction is that with respect to the issue of change over time in inequality, it

really doesn’t matter so much which measure one uses. Inequality within countries

changes only very slowly over time, and hence we should not discount differences of plus

29 For the whole 1980-1998 period for all countries, there are 429 country-year observations in the OK/national WIID dataset; there are 1741 in UTIP over the same period. 30 See Galbraith and Kim (2003) for a lengthy discussion of WIID, UNIDO and UTIP. 31 The overall correlation between UTIP and WIID country-year observations is above .70.

23

or minus 5% in inequality over two decades. And on this dimension WIID and UTIP are

similar – on both measures, inequality over the past two decades increased more (or

decreased less) in the developing world than in developed countries. Given that the trends

in the data are similar on both measures and that the overall correlation between them is

high, I choose to rely on the more plentiful UTIP data for the over-time analyses reported

later in this article.

Summary The data on inequality among and within countries demonstrate two central facts

about the 1980s and 1990s. First, with the dramatic exceptions of India and particularly

China, the gap in per capita incomes between the developed and developing worlds

widened significantly (no matter how one converts currencies). Second, the picture on

changes in inequality within countries was somewhat better for developing than for

developed countries. Conservatively, inequality increased less quickly in the developing

world.

But what about the effects of globalization? My strategy of beginning with a

description of trends in inequality is consistent with the way most people tend to think

about the problem. Whatever might have been going on with global inequality, the

common view is that globalization – ubiquitous if not all powerful – is implicated, for

good or ill. Let me now begin to probe that assumption.

4. Globalization

The big picture There can be little doubt that the world has globalized rapidly in recent decades.

No matter how many times you see the numbers, they continue to pass the interocular test

24

– they hit you right between the eyes. Figure 1 presents data on some basic indicators of

increasing international interconnections (the broadest definition of globalization) over

the 1980s and 1990s, normalized so that 1980 =100 (and compared against a baseline of

growth in worldwide GDP). International trade grew the least quickly among these

measures, but even trade growth far outstripped that for world GDP. The real volume of

exports and imports increased by about 280% over the two decades to over $16 trillion

(in 1995 dollars), or almost four times as quickly as total world economic output.

Figure 1. The dimensions of globalization

0

100

200

300

400

500

600

700

800

900

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

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1980

= 1

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Trade International capital flowsInternational phone calls Foreign population (OECD only)World GDP

25

Capital flows across national borders – comprising inflows and outflows of both

foreign direct investment (purchase of lasting and significant stakes in a foreign fixed

asset) and portfolio investment (stocks, bonds and bank lending, but excluding foreign

currency transactions) – almost quadrupled during the 1990s alone.32 For the full 1980-

2000 period, the growth in global capital flows was close to 600% (more than twice as

fast as the rate for trade), rising to roughly 10 trillion dollars per year.

The figure also highlights two other facets of globalization, the international

movement of people and cross-border communication among them. Considerable barriers

to immigration remain in most countries. Yet for the OECD as a whole (the only part of

the world for which systematic data are available), the number of residents who were

either born in or citizens from other countries more than trebled from 14 million in 1980

to 55 million in 1999 (or roughly 6% of the OECD’s total population). Finally, the

number of minutes spent making international telephone calls mushroomed by almost

800% between 1980 and 2000, to 24 minutes per year for every person on the planet. Of

course, the internet has been so revolutionary that it is impossible to display on the same

scale. According to the World Bank, there were roughly 70,000 internet users around the

world in 1989 (the first year for which the data were reported). By 2001, the number had

risen to 500 million.

My focus in this article is on globalization as an economic phenomenon. This is

not to deny the importance of the movements of people, information and ideas around the

world to broader (and appropriately so) conceptions of globalization, nor to suggest that

these have no economic consequences. But given how much they are discussed and

disputed, the linkages between trade and capital movements (the bread and butter of 32 Foreign exchange transactions were estimated at well over one trillion dollars a day in the late 1990s.

26

economic globalization) and inequality around the world clearly merit detailed

investigation.

Trade and capital flows Table 6 displays more detailed data on trade flows in the past two decades, now

normalized in terms of GDP. Combined exports and imports constituted roughly two

fifths of the GDP of both the developed and developing worlds in the early 1980s (even

though developed country trade comprised about 75% of world trade at the time). But

whereas trade remained a relatively constant portion of GDP for the developed world

throughout the 1980s and 1990s, it increased over the two decades by about 50% in

developing countries (to comprise almost one third of world trade by the end of the

1990s).

Notwithstanding the recent rancor about unfair subsidies for agricultural

producers in the US and Europe, agricultural exports constituted a paltry 0.6% of

developing country GDP by the end of the 1990s.33 Exports of manufactures dwarfed

those of agricultural products, with growth of more than 150% during the 1980s and

1990s.

Thus, the dramatic increase in the importance of manufacturing exports from

developing countries is the big story of the last twenty years with respect to global trade.

These data call into question how wise it is for developing countries to hang up the Doha

Round of WTO talks on the issue of agricultural protection in developed countries. But it

33 These data no doubt understate the centrality of agriculture (for domestic consumption) in developing countries. But overall employment in agriculture has declined on the same trajectory as agricultural exports. For example, the World Bank estimates that in the early 1980s, 56% of workers in middle-income countries were employed in agriculture (with the figures certainly higher in low-income countries); by the late 1990s the number had shrunk to 38% (WDI 2002).

27

is also easy to see why manufacturers and their workers in the US and Europe are so

worried about “low wage imports”.

Table 6. International trade (exports and imports)

1980-1982 (%GDP)

1998-2000 (%GDP) % Change

A. Developed countries Total 41.2 43.5 5.6% of which: Agricultural imports 0.7 0.4 -44.7% Manufacturing imports 14.7 14.4 -2.3% B. Developing countries Total 37.8 55.9 48% of which: Agricultural exports 1.2 0.6 -53% Manufacturing exports 5.7 14.6 158%

Things were quite different with respect to capital flows. Table 6 demonstrates

that gross capital flows constituted a relatively similar portion of GDP for developed

(9.1%) and developing (7.4%) economies in the early 1980s (much smaller ratios than

was the case for trade). By the end of the 1990s, however, international capital flows

more than trebled to almost 30% of GDP in the developed countries, whereas the capital

flows/GDP ratio only increased by about one quarter for developing countries (to 12% of

their combined GDP). As a result of these divergent trajectories, the proportion of the

world’s total capital flows involving developed countries increased from three-quarters in

the early 1980s to fully 90% by the end of the 1990s. In both developing and developed

countries, FDI increased much faster than international portfolio investments. These

trends are hard to reconcile with criticisms of “footloose finance” coming increasingly to

dominate economic life in the developing world. But they do amply demonstrate the

28

“multinationalization of production” (not only substituting FDI for exports but also

creating global supply and distribution chains) in the latter part of the twentieth century.

Table 7. International capital flows (inflows and outflows)

1980-1982 (%GDP)

1998-2000 (%GDP) % Change

A. Developed countries Total 9.1 28.5 215% of which: FDI 1.4 7.9 447% Portfolio 7.6 20.6 171% B. Developing countries Total 7.4 12.0 63% of which: FDI 1.0 3.7 268% Portfolio 6.4 8.3 30%

It should be remembered, however, that portfolio flows are larger in absolute

volume than FDI. Moreover, the data in Table 7 are for capital flows both into and out of

countries. Net portfolio flows were much more volatile in developing countries than in

developed ones – particularly during the 1990s when financial crises swept through first

Latin America and later East Asia. In addition, whereas capital movements were

relatively balanced between inflows and outflows in the developed countries, developing

countries were almost exclusively “importers” of capital (and hence often subject to the

whims of its owners, as in the financial crises of the 1990s).

Table 8 assesses the impact of China and India on the trade and capital flows

numbers in the developing world. The growth of both trade and capital flows in China

during the 1980s and 1990s was astounding. The expansion of Indian trade and capital

flows was not nearly so impressive, but the rate of change still far outstripped the pace of

globalization in the rest of the developing world as a whole.

29

Table 8. Trade and capital flows in China and India

A. Trade 1980-1982 (%GDP)

1998-2000 (%GDP) % Change

China 16.2 43.2 167% India 15.6 27.7 77% Other developing 46.9 60.6 29% All developing 37.8 55.9 48%

B. Capital 1982 (% GDP)1998-2000 (%GDP) % Change

China 1.1 11.2 944% India 0.2 1.6 684% Other developing 6.6 12.8 93% All developing 5.9 12.0 105%

The combined impact of China and India on developing country trade was

immense. Trade in the rest of the developing world only increased by 29% during the

1980s and 1990s – much much less than the 48% when China and India were included.

Taking China and India out of the equation had less impact on the picture of growth in

capital flows in developing countries – even though the rate of growth was extremely

high in these two countries – because the volumes involved were much smaller

(particularly in India).

In sum, Tables 6-8 show that trade and capital flows increased markedly around

the world in the 1980s and 1990s. Although the preponderance of cross-border economic

activity still takes place in the developed world, international economic integration has

been just as much a reality for developing countries (relative to the scale of domestic

economic activity in them). But there has also been an important difference in how

economic globalization has manifested itself in developing and developed countries.

Explosive trade growth (particularly in manufactures) has been the big story in the

developing world, whereas the boom in cross border capital movements was far more

pronounced in developed countries.

30

Policy Liberalization What caused the dramatic rise in international economic activity? I have

attempted elsewhere to sort out the various contending arguments from technological

determinism to global ideological change (Garrett 2000).34 For present purposes it is

important to note that the removal of policy barriers to international trade and

transactions on the capital account (what economists call “liberalization”, and opposed to

the deregulation and privatization of domestic economies) has also been a distinctive

feature of the world economy in the past twenty years.

Table 9. Tariffs and capital account restrictions

A. Average tariff rate (lower = fewer restrictions on imports) 1980s 1997-1999 % Reduction in tariffs Developed countries 7.9 5.4 31% Developing countries 29.9 13.4 55% B. Capital account openness index (higher = fewer restrictions on capital flows) 1980-1982 1998-2000 % Reduction in restrictions Developed countries 2.5 5.4 118% Developing countries 1.2 2.4 96% Tariff data from: http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/TRADE/0,,contentMDK:20103740~menuPK:167374~pagePK:148956~piPK:216618~theSitePK:239071,00.html. 1980s tariffs: 1984-1986 for developing countries and 1988-1990 for developed countries. The Capital account openness index is derived from IMF data on the policies of national governments.35

The patterns in Table 9 reinforce what we have learnt with respect to international

economic flows. Tariffs declined appreciably in both developed and developing

countries, but the reduction was much more pronounced in developing countries (where

trade growth was also much faster) – even though average tariffs in developing countries

34 Garrett, G. 2000. The Causes of Globalization. Comparative Political Studies. Vol 33: 6-7, 941-991. 35 Brune, Garrett, Guisinger. 2003. The Political Economy of Capital Account Liberalization. Working Paper.

31

today are still much higher than they were in developed countries in the 1980s.36 The

reductions recorded by the IMF in policy restrictions on the capital account were at least

as dramatic as was the case for tariffs, and the pace of liberalization was similar in

proportionate terms in developed and developing countries. But given their very different

starting points, capital accounts in the developing world are still not quite as open they

were in the developed countries twenty years ago.

In turn, liberalization seems to have stimulated cross border trade and capital

flows. Here are two simple equations estimating for all countries around the world the

impact during the 1980s and 1990s of tariffs and capital account openness on trade and

capital movements, respectively, controlling for the well known effects of country size

(measured by population in millions) and level of development (GDP per capita in

thousands, PPP). The terms in parentheses are the standard errors of the estimates. All of

the estimated coefficients were statistically significant at the .01 level, in two-tailed tests:

TRADE = 1.1GDPPC*** – 0.04POP*** – 1.0TARIFF*** + 87.0 (0.2) (0.01) (0.1) R-squared: 0.17

based on 1053 country-year observations CAPITAL = 1.0GDPPC*** – 0.02POP*** + 2.1CAOI*** + 6.7 (0.2) (0.007) (0.4) R-squared: 0.06 based on 2650 country-year observations These equations are not meant to be definitive. But they do demonstrate a clear

positive relationship between policy liberalization and greater international economic

activity. Reducing tariffs by one percentage point was associated with an increase in trade

of one point of GDP; a one unit increase in the Capital Account Openness Index

36 It is true that cuts in developed country tariffs have been accompanied by increasing recourse to various sorts of non-tariff barriers to trade (from quotas to “voluntary export restraints” by developing countries) (Garrett 1998). But most experts believe that NTBs in developing countries are at least as extensive as they are in the developed world. Hence tariffs still are a good proxy when comparing overall trade policies in the two sets of countries.

32

(measured on a 0-9 scale) was associated with a two point increase in capital flows as a

percentage of GDP. These are powerful effects that indicate the central role policy

liberalization has played in the process of globalization.

Connecting globalization to inequality – temptations and perils This section has shown that the world economy globalized substantially during

the 1980s and 1990s, in terms both of international economic flows and of the foreign

economic policies governing them. Over the same period, the gap in per capita incomes

between the developed and the developing world grew (with the important exceptions of

China and India), whereas inequality within countries (particularly in the developed

economies of the industrial north) also tended to increase. This set of facts is grist for the

mill among globalization’s critics.

But the temptation to conclude on the basis of the data presented in this section

that globalization caused the increases in inequality we have observed should be resisted.

A lot of important phenomena trended together during the 1980s and 1990s, making it

difficult to say precisely what caused what. For example, the number of democracies in

the world more than doubled to about 100 countries over the two decades. The naïve

view, of course, is that democracy – because it empowers everyday people – promotes

equality. There is actually little evidence that this has happened. But equally, no one

would argue that democratization has been primarily responsible for the increases in

inequality among and within countries that have taken place in the past twenty years –

even though the global correlations are just as strong as for international economic

integration.

33

Perhaps there is some underlying phenomenon that led not only to

democratization, but also to globalization. Pundits often point to a shift in the political

center of gravity (for example’s Fukuyama’s (1989) provocative “end of history” claim).

But if this has happened, why did it? Is the communications and information technology

revolution at the root of everything?

I raise these questions not to get to the bottom of the causal chain but simply to

underscore the folly of inferring causality on the basis of variables that have been

trending together at the global level. I do believe that changes in government policies

have been an important driver of globalization, and that we can and should assess its

impact on outcomes like economic growth and the distribution of income. But we just

shouldn’t do this on the basis of sweeping trends over time: more globalization, more

global inequality, ergo globalization caused inequality.

The central point that is missed by eyeballing global trends is that the extent to

which different countries have globalized has varied tremendously. In the signature case

of trade, for example, the sum of exports and imports increased as a percentage of GDP

during the 1980s and 1990s in over 80 countries for which we have the data, but it

declined in more than 50 countries as well (with declines of more than 20% in 16

countries). This variation is more than just “noise” around the global trend, and it worth

considerable exploration in terms of its impact on economic growth and inequality.

Inferring causality is still hard, but at least we have more data, and more variation in the

data, to work with. Let me now move on to the more complex, but I hope more revealing,

reality of globalization and inequality at the national level.

34

5. Globalization and inequality at the country level

Cross-national variations in globalization Table 10 presents data on the most and least globalized countries in the world at

the turn of the millennium, based on international economic flows as well as national

foreign economic policies.37 The countries in the top 10 traders were very rich, very small

or both, whereas those at the bottom were very large, very poor, or both (consistent with

“gravity” models of trade). A similar pattern was evident for the top and bottom countries

in terms of capital flows, though here per capita income played the dominant role.

Turning to foreign economic policies, the countries with the lowest tariffs tended again to

be both small and wealthy, whereas those with the highest tariffs were very poor (with

the stunning exception of the tax haven, the Bahamas). Countries with very high per

capita incomes also populated the top 10 capital account openness grouping, whereas

many developing countries (including some of the very biggest ones) continued through

2000 to have completely closed capital accounts on IMF definitions.

One could spend a great deal of time dissecting these data, but I don’t think this

would be productive – for two main reasons. First, as I have already mentioned, relatively

invariant factors, such as a country’s size and its per capita income, have a big impact on

the magnitude of international economic flows into and out of it. For example, I doubt

many people would include tiny Swaziland in their lists of the world’s most globalized

countries, nor the India of Bollywood, software engineers and call centers on their least

globalized list.

37 Since national data tend to be more volatile on a year-to-year basis than the averages for large numbers of countries, these data are based on the period 1996-2000 rather than just 1998-2000.

35

Second, the term globalization connotes a dynamic process of change: increasing

international interconnections over time. It is not a steady state phenomenon. For

example, US trade increased substantially during the 1980s and 1990s, even though it

still only accounted for less than a quarter of GDP at the turn of the millennium (very low

by international standards). It was this growth in trade, rather than its relatively low level,

that precipitated intense political divisions that have had and continue to have a marked

effect on American politics and society.

Table 10. Levels of international economic integration in the late 1990s

Flows Policy

Trade (%GDP) Capital flows (%GDP) Average tariffs (%) Capital account openness

(0=closed; 9=open) Top 10

Singapore 319 Bahamas 396 Hong Kong 0 Denmark 9 Hong Kong 274 Bahrain 207 Switzerland 0 Switzerland 9 Eq. Guinea 213 Eq. Guinea 184 Estonia 0 Vanuatu 9 Luxembourg 208 Ireland 168 Singapore 0 Liberia 8.8 Guyana 207 Hong Kong 166 United Arab Em. 4 Panama 8.4 Malaysia 205 Malta 128 Iceland 4 Hong Kong 8 Malta 190 Belgium 82 Lithuania 4 Ireland 8 Maldives 176 Switzerland 78 Norway 4 Netherlands 8 Swaziland 165 United Kingdom 73 New Zealand 5 New Zealand 8 Estonia 163 Panama 73 Oman 5 Palau 8

Bottom 10 Rwanda 31 Tanzania 4 Namibia 24 50 countries, incl: 0 Fr. Polynesia 30 Sudan 4 Bangladesh 25 Afghanistan India 27 Madagascar 4 Mauritius 26 Brazil Burundi 27 Iran 3 Egypt 28 Chile Sudan 26 Belarus 3 Tunisia 30 China United States 24 Bangladesh 3 Burkina Faso 32 India Argentina 22 Samoa 3 Bahamas 32 Iran Brazil 19 Nepal 2 India 34 Iraq Japan 19 Haiti 2 Cambodia 35 (Sub-Saharan. Africa) Myanmar 2 Rwanda 1 Pakistan 44 (Post-comm. countries)

For both reasons, my focus is on changes in the international economic

integration of countries from the first half of the 1980s (1980-1984) to the second half of

36

the 1990s (1996-2000). I measure everything in terms of percentage change to take into

account the very different starting points of countries around the globe.

Table 10 reprises the top and bottom 10 lists for trade and capital flows, but this

time in terms of change over the last two decades. Several countries in the top 10 changes

in trade list are not surprising – China, Mexico, Thailand and Turkey. But I doubt even

keen observers of the international economy would have picked Laos to top the list

(admittedly from a very low starting point of under 10% of GDP), or known that Ghana,

Nicaragua and Nigeria were also in the top 10, or indeed understood that no stable

industrial democracy made the list. The bottom 10 (featuring countries where trade as a

portion of GDP declined by more than 25%) was more predictable, with a healthy

smattering of nations from the Middle East and Sub-Saharan Africa (as well as hyper-

closed Myanmar). But the bottom group also includes Japan, where declining trade has

gone hand in hand with economic stagnation since the late 1980s.

The countries in which international capital flows increased the most from the

early 1980s to the later 1990s were nothing if not eclectic. The bottom 10 list was

perhaps more predictable, but the sheer magnitude in the drop-off in capital flows in

these countries is worth emphasizing (in each case, more than 45% from 1980-1984

levels).

If the data on trade and capital flows are aggregated (by summing their

standardized scores), the top 10 includes at least five countries that are often thought to

be in the vanguard of globalization – China, Hungary, India, Ireland and Mexico. The

37

bottom 10 also includes some of the usual suspects from the Middle East and Sub-

Saharan Africa. But Israel and Japan also made the list.38

Table 11. Changes in international economic flows from the early 1980s to the late 1990s

Trade Capital Overall

Top 10 Lao PDR 822% Bahamas, The 10964% 1. Lao PDR Ghana 581% Lao PDR 2453% 2. Ghana China 153% Malta 1327% 3. China Mexico 146% Hungary 1279% 4. India Nicaragua 116% India 1219% 5. Ireland Philippines 108% Bahrain 1152% 6. Mexico Nigeria 105% Ireland 1144% 7. Nicaragua Maldives 103% Sweden 1026% 8. Hungary Thailand 103% Syria 919% 9. Philippines Turkey 103% Albania 864% 10. Nigeria

Bottom 10 Niger -27% Costa Rica -47% 100. Rwanda Saudi Arabia -27% Haiti -47% 101. Japan Botswana -29% St. Lucia -47% 102. Barbados Japan -29% Saudi Arabia -47% 103. Israel Macao, China -34% Guinea-Bissau -61% 104. Haiti Bahrain -34% Botswana -65% 105. Togo Egypt -39% Rwanda -71% 106. Saudi Arabia Central African Republic -40% Panama -73% 107. Egypt Suriname -72% Vanuatu -74% 108. Botswana Myanmar -91% Antigua and Barbuda -76% 109. Suriname

The data on changes in foreign economic policies at the national level are

presented in Table 11. There was only one developed nation among the 10 countries that

reduced tariffs the most – Switzerland. The remaining top trade liberalizers were spread

around the developing world, including countries from Africa and Latin America as well

as from Asia. In contrast, the most noticeable characteristic of the countries with the

greatest increases in tariffs from the early 1980s to the late 1990s is that four Middle 38 The World Bank on has data on trade and capital flows going back to 1980 for only a little more than half of the roughly 200 countries in the world today. Many of the omissions are small and new nations, but the post-communist nations are the most underrepresented group.

38

Eastern nations made the list. Turning to capital account policy, there were more

developed countries in the top 10 liberalizers than on the other lists, but the group

included Uganda and Zambia as well. The most surprising country in the bottom 10 is no

doubt the US. On IMF definitions, America’s capital account became more closed over

the period, though it must be remembered that in the early 1980s the US capital markets

were among the most open in the world.

Table 11. Changes in foreign economic policies from the early 1980s to the late 1990s Tariffs Capital account openness Overall

Top 10 Switzerland -100% Ireland 800% 1. New Zealand Central African Republic -78% New Zealand 800% 2. Zambia Bangladesh -74% Zambia 800% 3. El Salvador Benin -71% El Salvador 780% 4. Peru Dominica -70% Denmark 733% 5. Nicaragua Uruguay -70% Nicaragua 700% 6. Trinidad & Tobago Brazil -68% Peru 700% 7. Ireland Peru -68% Trinidad & Tobago 700% 8. Kenya Ecuador -67% Uganda 660% 9. Uganda Grenada -64% Jamaica 640% 10. Jamaica

Bottom 10 Papua New Guinea 17% Yemen, Rep. -11% 84. Madagascar Madagascar 18% Lebanon -14% 85. Malawi Poland 19% Bahrain -18% 86. Tunisia Czech Republic 22% Saudi Arabia -20% 87. Bahrain Yemen, Rep. 23% Oman -21% 88. Yemen, Rep. Guinea 53% United States -27% 89. Guinea Saudi Arabia 61% St. Lucia -30% 90. Syria Syria 63% Indonesia -40% 91. Saudi Arabia Oman 82% Seychelles -44% 92. Oman Zimbabwe 152% Zimbabwe -50% 93. Zimbabwe

Capital account openness index from Brune (2003). Data are percentage changes between 1980-1984 (capital account policy) and 1986-1990 (tariffs) and 1996-2000.

Aggregating the two policies measures into a single index generates a top 10 list

that includes two stable industrial democracies that had pro-globalization epiphanies –

Ireland and New Zealand. But I doubt many people would have anticipated most of the

39

other countries that made the list. The bottom 10 was much more predictable, comprising

exclusively inward looking regimes in the Middle East as well as Sub-Saharan African

countries.

One way to highlight how different the world of globalization looks when one

focuses on recent changes in international economic flows and foreign economic policies

rather than their levels is to compare my analysis with other prominent globalization

indices. The AT Kearney Globalization Index, for example, is published each year in

Foreign Policy. Its 2003 top 20 list is dominated by small and rich countries. Indeed, the

list contains only one developing country – Malaysia. Countries like China and India, and

Argentina and Mexico, do not get onto AT Kearney’s radar because these large and

relatively poor nations are not as open – in terms of current levels of economic

integration – as the small countries of continental Western Europe or Hong Kong and

Singapore. But it is these large developing countries that are in the vanguard of

globalization, in terms of the rapidity of international economic integration in recent

decades.

The impact of increasing economic integration on economic growth and inequality within countries

So what happened to economic growth and distribution of income in countries

that became increasingly integrated into the international economy, compared with those

that did not? Table 12 takes an initial pass in terms of correlations between changes in

international economic flows and changes in economic outcomes between the early

1980s and the late 1990s. I divide the world not only between developed (high-income)

countries and the rest, but also between low- and middle-income countries in the

developing world (based on per capita incomes in 1980). As my analysis amply

40

demonstrates, simply calling the 150 or so countries in the world that do not meet the

high income threshold “developing” conceals important differences within this enormous

and broad category.

Table 12. Changes in international economic flows, economic growth and changes in the distribution of income at the national level

Increasing per capita income Increasing income inequality Growth in: Trade Capital Flows Trade Capital Flows World 0.10 0.00 -0.06 0.23 High-income countries 0.48 -0.14 0.31 0.18 Middle-income countries -0.14 -0.03 -0.03 0.47 Low-income countries 0.23 0.53 -0.14 -0.40

Data are correlation coefficients (Pearson’s r)

For all the countries in the world, there was a slight positive association between

trade growth and increases in per capita income, but no relation between international

capital flows and economic growth. These aggregate correlations, however, belie

substantial variations among countries at different levels of development. In the high-

income countries, faster trade growth was strongly associated with faster economic

growth (but interestingly the growth-capital flows correlation was weakly negative). In

the low-income grouping, countries in which both trade and capital flows increased more

quickly also grew faster, and this association was very strong in the capital flows-growth

case. But the story was quite different in middle-income countries, where faster growth in

trade and capital flows was associated with slower, not faster, economic growth (though

the associations were weak).

Turning to the distribution of income within countries, for all the nations of the

world, countries with faster rates of trade growth experienced slightly slower declines in

income inequality, whereas faster growth in capital flows was associated with greater

increases in inequality. But again, the experiences of the high and low-income countries

41

were diametrically opposed. Growth in trade and capital flows ameliorated income

inequality in the world’s poorest nations, but increased it in the most developed countries.

The middle-income countries looked like their more developed counterparts, with greater

international economic flows being associated with increasing income inequality.

These patterns of correlations fit the “three worlds of globalization” thesis I

sketched at the beginning of this article. The experiences of high and low-income

countries meet the expectations of basic economic theory. Increased international

economic integration was good for growth in developed countries, but even better for per

capita incomes in low-income countries – because of the transfer of technology and

know-how. Integration exacerbated inequalities in the distribution of income in high-

income countries, but it ameliorated inequalities in low-income nations – because the free

movement of goods, services and capital empowers less skilled labor in poor countries

but weakens their position in rich countries.

In contrast, the economic flows data suggest that globalization was a double bad

in middle-income countries – nations in which international economic flows increased

more tended not only to grow more slowly and but also to experience greater increases in

inequality. This does not fit so neatly with standard economic theory, but it is explicable

in terms of the inability of these countries to compete in neither low wage markets nor the

knowledge economy.

There are good reasons, however, to be skeptical about placing too much weight

on these correlations with international economic flows – with respect to changes in per

capita incomes in particular. Countries that are growing rapidly are magnets for trade and

investment – as the cases of China and India attest. Whether globalization independently

42

has further stimulated economic growth in these countries is harder to assess. The same

question obtains at the other end of the spectrum. Countries that were doing badly in

terms of economic growth were unlikely to be very successful in attracting trade or

foreign capital; indeed both may have hemorrhaged as a result. But did globalization add

to their woes, or did it ameliorate them?

One simple way to check whether globalization actually affected economic

growth (rather than only being driven by it) is to focus on changes in foreign economic

policy (rather than economic flows) as indicators of globalization. We know that tariffs

and capital account policy have a major impact on trade and capital flows, so they are a

good indicator of globalization at the national level. It might still be the case that

governments react to better economic growth by liberalizing foreign economic policy, but

this is much less plausible than the notion that growth attracts trade and international

capital. As a result, we can be more confident about inferring globalization growth

causality when using policy change to indicate increasing (or decreasing) economic

integration.

Given that the reverse causality problem applies principally to economic growth, I

will first briefly discuss the change in foreign economic policy-change in inequality

correlations before moving on to a somewhat more detailed discussion of the associations

between policy and growth in per capita income.

The pattern of correlations in Table 14 is very similar to that in the right hand

panel of Table 12. That is, policies that increased openness to international markets were

associated with growing inequality in high-income countries but with declining inequality

in low-income countries; the experiences of the countries in the middle more closely

43

approximated outcomes in the developed world. Thus, the results of globalization on the

distribution of incomes within country look basically the same irrespective of whether

increases in international economic flows or reductions to policy barriers to cross-border

movements of goods, services and capital are used to measure globalization.

Table 13. Changes in foreign economic policy and income inequality

Tariff reductions Increased capital account

openness World 0.05 0.11 High-income countries 0.61 -0.08 Middle-income countries 0.08 0.21 Low-income countries -0.34 -0.37

Data are correlation coefficients

Table 14 takes a closer look at the data on tariff reductions and economic growth

from 1986-1990 to 1996-2000. Instead of summary correlations, I discuss all countries

for which the data are available (with percentage change in per capita income reported

alongside each country name). Increases in per capita income or tariff reductions greater

than the median (measured separately at each level of development in panels A, B and C

so as not to contaminate the comparisons with dynamics specific to different levels of

development) were classified as “high”, whereas those below the median were deemed

“low”. Larger numbers of countries in the high-high and low-low cells would indicate

that tariff reductions were associated with better outcomes. In addition, I present overall

averages for high and low tariff reducers respectively so that readers can easily compare

mean increases in per capital income for the two groups (i.e. reading down the columns).

Panel A suggests that high-income countries that reduced tariffs more during the

1980s and 1990s experienced somewhat faster rates of economic growth. Norway,

Australia and Canada all reduced tariffs by more than the median for the group (30%);

44

growth in per capita incomes was also “high” in these countries. Conversely, Iceland, the

Bahamas, Saudi Arabia and the United Arab Emirates were in the low-low cell.

Table 14. Tariff Reductions and Economic Growth

A. High income countries

Decrease in Tariffs Low High Iceland 10% New Zealand 16% Low Saudi Arabia -4% Switzerland 13% Bahamas, The -5%

Increase in per United Arab Emirates -7% capita income Israel 24% Norway 52%

High Japan 21% Australia 41% Canada 28% EU 19% Average 6%Average 16%

(excl. Saudi Arabia & UAE) 13%

Panel A also includes aggregated data for 11 members of the European Union. As

part of a customs union, EU countries share common external tariffs (with none among

members). From the late 1980s to the late 1990s, average tariff rates in the EU were

reduced by a little above the median, whereas growth was also slightly above the median.

Simply averaging growth rates among high and low tariff reducers suggests better

performance in the “high” category, but it is clear that most of this difference was driven

by the dire experiences of Saudi Arabia and the United Arab Emirates. Neither country

liberalized; both experienced declining real per capita incomes. Most of the income

decline, of course, is attributable to substantial cuts in world oil prices in the latter 1980s

and 1990s. This points to the broader fact that there are profound differences between the

wealthy oil exporters in the Middle East and the stable industrial democracies, and trade

policy is just one manifestation of these differences.

45

As a result, the prudent conclusion to draw from panel A is that trade

liberalization was probably good for growth in high-income countries in the past twenty

years, but that the magnitude of this effect was fairly limited.

B. Low-income countries

Decrease in Tariffs Low High Ghana 17% Benin 9% Malawi 15% Kenya -2% Low Senegal 2% Central African Rep. -14% Madagascar -12% Zambia -21% Cameroon -27%

Increase in per Congo, Dem. Rep. -54% capita income Sri Lanka 43% China 126%

St. Vincent & Grenadines 33% Indonesia 50% High Nepal 28% India 45% Egypt, Arab Rep. 24% Bangladesh 30% Pakistan 19% Burkina Faso 20% Bolivia 17% Average 8%Average 26% (excl. China) 15% Sub-Saharan Africa only -10% -2%

There was more consistent evidence of a trade liberalization-faster economic

growth connection among low-income countries (panel B). Even if one excludes China,

average rates of growth in real per capita income were almost twice as high among the

low income countries that reduced tariffs by more than the median amount (47%, a much

greater proportionate reduction than for the high income countries), compared with those

below the median.

All six countries in the low-low cell were in Sub-Saharan Africa. But equally, the

above median trade liberalizers that experienced less than median economic growth were

also all in Sub-Saharan Africa. It is just the tragic case that growth in Africa has been

46

stagnant for decades – for a variety of reasons (not the least of which have been political

instability, civil wars and, more recently, the AIDs pandemic).

Nonetheless, it is important for our purposes to note that growth performance was

relatively better (though obviously still very poor by global standards) among African

nations that liberalized trade more; the countries that liberalized less did even worse.

Even amid all the misery on the continent, trade liberalization did promote growth. It thus

pretty safe to conclude for all low-income countries that trade liberalization helped during

the 1980s and 1990s, and not only in stunning success stories like China and India.

Unfortunately, the converse held among middle-income countries – trade

liberalization went hand in hand with slower economic growth (panel C of Table 14).

Countries that reduced average tariff rates by more than the median for the middle-

income group (44% from the late 1980s to the late 1990s) tended to have lower increases

in real per capita income over the same period (17%) – compared with 29% for the high

tariff reducers.

The countries in the high tariff reductions-low growth cell were concentrated in

Latin America and the Caribbean, whereas those in low tariff reductions-high growth cell

were spread more evenly around the world, but including all the Asian middle-income

countries (except the Philippines). This last observation reflects a longstanding homily of

development economics: stagnant per capita incomes in Latin America compared with

rapid growth in East and Southeast Asia.

But the table suggests that tariff reductions may have been implicated –

negatively – in this story. Those who continue to laud “export-oriented growth” in East

Asia often overlook the fact that these countries have long been reticent to remove

47

barriers to imports (i.e. tariffs), as well as maintaining significant restrictions on cross-

border capital flows. Conversely, the Latin American countries (under pressure from the

international financial institutions and the United States) engaged in widespread trade

(and capital) liberalization towards the end of the 20th century. The evidence suggests that

tariff reductions (let alone capital mobility) hindered economic growth in the region.

C. Middle-income countries

Decrease in Tariffs Low High Mexico 15% Colombia 16% Morocco 9% Guatemala 14% Barbados 7% Jamaica 13% Nigeria 7% Trinidad & Tobago 12% Zimbabwe 6% Philippines 10% Low Paraguay 1% Brazil 6% Hungary 0% Ecuador 3% Cote d'Ivoire -7% Peru 3% Algeria -8% Venezuela, RB 0% South Africa -5% Nicaragua -12%

Increase in per Congo, Rep. -25% capita income Chile 72% Thailand 69%

Korea, Rep. 72% Guyana 46% Malaysia 66% Belize 35% Singapore 65% Grenada 32% St. Kitts and Nevis 60% Uruguay 29% High Mauritius 52% Costa Rica 28% Cyprus 41% El Salvador 28% Portugal 35% Argentina 27% Antigua and Barbuda 33% Turkey 25% Tunisia 31% Syrian Arab Republic 30% Papua New Guinea 19% Average 29%Average 17% Latin America only 19% 6%

Interestingly, Chile (a posterchild for neoliberal policies)) reduced its tariffs by

less than the median for all middle income countries (and far less than the Latin

48

American norm) from the mid 1980s to the late 1990s (by 37%, admittedly on a lower

base than most of its neighbors because of the radical liberalization that took place in

Chile during the latter 1970s). But Chile grew over the same period as quickly as South

Korea – also a tariff liberalization laggard and a star growth performer. Both countries

also were very active in their use of capital controls, especially during the 1990s.

As was the case for Africa among the low-income countries, the overall middle-

income pattern – countries that liberalized trade more grew less quickly – was replicated

within Latin America itself (indeed the gap in growth between high and low liberalizers

was almost identical within Latin America and the middle-income world as a whole). As

a result, one cannot attribute the poor growth performance of Latin American trade

liberalizers to some overarching regional effect.

In sum, the most important feature of Table 14 is the marked difference between

the positive effects of trade liberalization in low-income countries and the negative

impact of liberalization in the middle-income world. One simple explanation that I have

already offered is that middle-income countries are neither fish nor fowl in the global

economy. They cannot effectively compete with China and other low-income economies

in the increasingly large global market for standardize manufactures. But neither can the

middle-income countries compete with the US and the other advanced industrial

democracies in the knowledge economy.

Let me now move from tariff reductions to the removal of barriers to cross-border

capital flows (i.e. capital account liberalization). The three panels of Table 15 are

identical in design to those in Table 14. Countries are divided into high and low

49

categories with respect to the capital account openness index, and the changes in

openness and per capita income are measured between 1980-1984 and 1996-2000.

Table 15. Increasing Capital Account Openness and Economic Growth.

A. High-income countries

Increase in capital account openness Low High Germany 32% Italy 35% Canada 28% Denmark 33% Kuwait 16% France 29% Low Bahamas, The 8% Sweden 26% Saudi Arabia -31% Iceland 26%

UAE -43% Greece 18% Increase in per New Zealand 16% capita income Hong Kong 84% Ireland 110%

Japan 49% Norway 52% United Kingdom 43% Spain 49% High United States 41% Australia 41% Netherlands 39% Austria 36% Israel 38% Finland 35% Belgium 36% Average 26%Average 39% (excl. Saudi

Arabia & UAE 38%

Cursory perusal of capital account liberalization and economic growth in the

high-income countries shows that with the exception of Saudi Arabia and the UAE, there

was little difference between countries that opened their capital accounts more and less

than the median. This might seem surprising to some, but despite a vast array of elaborate

econometric studies, no one has been able to come up with a strong growth-openness

relationship, even among the OECD nations.39

39 See Eichengreen 2002 for an excellent review of all the empirical work on capital account liberalization.

50

B. Low-income countries

Increase in capital account openness Low High Senegal 3% Kenya 3% Bolivia 1% Mali -3% Central African Republic -19% Gambia, The -7% Burundi -22% Togo -17% Low Cameroon -24% Madagascar -20%

Haiti -35% Rwanda -30% Niger -30%

Zambia -30% Sierra Leone -45%

Increase in per Congo, Dem. Rep. -57% capita income China 273% Sri Lanka 66%

Indonesia 90% Egypt 45% St. Vincent & Grenadines 82% Burkina Faso 29% India 78% Sudan 28% High Lesotho 51% Guinea-Bissau 13% Pakistan 47% Mauritania 3% Chad 18% Ghana 15% Malawi 11% Benin 6% Average 36%Average -3% (excl. China) 20% Sub-Saharan Africa only -1% -11%

Turning to the low-income countries in Panel B, the evidence here is the polar

opposite of that with respect to trade liberalization. Low-income countries that liberalized

their capital accounts by more than the median for the group as a whole grew less

quickly, even if one excludes China (which did not liberalize capital) from the analysis.

On average, per capita incomes actually declined among high capital account liberalizers

over the 1980s and 1990s. Again, it is important to note that most of the low-income

countries are in Sub-Saharan Africa. But even if one only examines developments in

Africa, the same pattern holds up. The African countries that liberalized their capital

51

accounts experienced poorer growth performance than those that did not (i.e. smaller

declines in per capita income from the early 1980s to the late 1990s).

C. Middle-income countries

Increase in capital account openness Low High Syrian Arab Republic 16% Jamaica 16% Brazil 15% Argentina 13% Panama 12% Hungary 11% Fiji 12% Guatemala 3% Suriname 11% Honduras 2% Iran, Islamic Rep. 10% Ecuador 0% Low Mexico 7% Philippines -2% Zimbabwe 4% Trinidad & Tobago -3% Nigeria -1% Paraguay -3% Gabon -10% Peru -5% Algeria -10% Jordan -14% Cote d'Ivoire -22% South Africa -14%

Increase in per Congo, Rep. -28% Nicaragua -33%capita income Korea, Rep. 170% Thailand 135%

Singapore 114% Mauritius 110% Chile 105% Botswana 93% Antigua and Barbuda 99% Grenada 86% Malta 94% Portugal 62% Cyprus 91% Turkey 51% High Malaysia 87% Dominican Republic 38% Seychelles 59% Costa Rica 31% Belize 52% Colombia 27% Swaziland 40% Guyana 27% Tunisia 37% Morocco 24% Uruguay 32% El Salvador 23% Barbados 22% Papua New Guinea 16% Average 39%Average 27%

The low-income pattern was replicated for the middle-income countries. Those

nations that liberalized capital flows the most experienced slower growth. This holds

irrespective of whether one considers all middle-income countries or only those in Latin

America.

52

In sum, the data presented in Table 15 reinforces the consensus that has emerged

among international and development economists since the Asian crisis of 1997-1998.

There are theoretical benefits from open capital accounts in terms of ensuring that

investment flows to where it can be most efficiently used. However, open capital

accounts also tend to increase volatility in capital flows – as the boom (rapid capital

inflows) and bust (outflows) of the Asian crisis and those that preceded it in the 1990s

amply demonstrate. Realizing the benefits of liberalization without incurring the

volatility costs entails having well developed domestic capital markets that are equipped

to manage and diversify risk. In most of the developing world (both low- and middle-

income countries), the requisite domestic institutions (most notably having to do with the

prudential regulation of banking systems) are absent or weak at best. The countries that

liberalized (often under pressure from the IMF) under these conditions suffered. As the

evidence has accumulated, even the IMF has backed away from its earlier insistence that

current and capital account liberalization should be pursued with equal vigor.

6. The politics of globalization I have spent so much time puzzling over data in this article because the devil

really is in the detail when it comes to figuring out how the costs and benefits of

globalization have been apportioned around the world. Nonetheless, I hope readers will

agree that my analysis has generated robust conclusions about the three worlds of

globalization. I conclude by discussing their political and policy implications.

My findings about high-income countries represent an additional voice in what is

by now a loud choir. Economic globalization (the liberalization of both trade and capital

movements) has benefited the world’s most developed countries in aggregate by

53

stimulating economic growth at a time when their economies were slowing down in the

aftermath of the oil shocks. But globalization has also exacerbated the growing gap

between those who own assets in and work in the knowledge economy (broadly

construed as all high-value added production) and those who do not.

Governments in the west will continue to have to deal with the political fallout of

anti-globalization activism supported by those who are ill-equipped either for the

knowledge economy or for global competition in less-skilled products. The fact that

globalization will continue to increase aggregate wealth, however, gives governments the

ability to cushion and empower the losers without slowing down the forces of market

integration. Partisan politics will no doubt play a major role in determining how broadly

the fruits of globalization are spread. But this struggle is just the old wine of capitalist

democracy, as we have known it for over a century, in the new bottle of the global

economy.

The sharp distinction I have drawn between globalization’s effects in the middle

vs. low-income countries is more novel. When reflecting upon the policies of the

Washington consensus 15 years after he coined the term, John Williamson concluded that

the policies he described were not only right; he believes they have also worked:

The big changes in development thinking that underlay the Washington Consensus—which were recognition of the importance of macroeconomic discipline, trade liberalization rather than import substitution and industrialization, and development of the market economy rather than reliance on the leading role of the state—they were as valid in developing countries as they’ve long been regarded in the OECD … It (the Washington Consensus) was the end of intellectual apartheid, in which there were the First, Second and Third Worlds, with different economic laws applying in all three. I think that’s something to be celebrated and not mourned.40

40 http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:20153468~menuPK:34457~pagePK:34370~piPK:34424~theSitePK:4607,00.html

54

My analysis suggests that Williamson overstates the case for the Washington

consensus with respect to trade liberalization while also overlooking the damaging role

that capital account liberalization has played in developing countries. He is right only

when it comes to the effects of trade liberalization on the “Third World” (that is, low-

income countries with average per capita incomes of less than a thousand dollars a year,

more or less). These countries have benefited from trade liberalization; and these benefits

have accrued disproportionately to poorer people in them – not only in the stunning

success stories of China and India, but even when one compares trade liberalizers and

non-liberalizers amid the ongoing despair and deprivation of Sub-Saharan Africa.

Williamson contends that full capital account openness was not a central feature

of the Washington consensus (though his characterization did include openness to FDI

inflows). He might be right with respect to his characterization, but in practice the

international financial agencies – particularly the IMF, supported by the US Treasury –

did push very hard for widespread financial liberalization for much of the 1990s. My

analysis shows that the poor countries that did as they were told suffered harsh

consequences in the financial crises of the 1990s, prompting even the IMF in the end to

back off.

The globalization balance sheet for low-income countries is thus simple: trade

liberalization has been a boon; capital account liberalization has been a bust. The

prospects for further global trade liberalization were not helped by the acrimonious

failure of the Cancun WTO summit in September 2003. There are two issues on the table:

developing countries want the west to reduce the protection of domestic agriculture; the

55

west wants developing countries to accept limitations on their ability to appropriate

intellectual property developed in the west.

The issue of intellectual property is difficult since it is clear that the globalization

success stories among low-income countries have been fueled by the ability to mix

western technology with cheap labor – in China above all. But my analysis suggests that,

irritating as agricultural protection in America and Europe is (for everyone except the

farmers who benefit from it), the low-income countries should give up their crusade if

this can be used as a bargaining chip to limit WTO intervention in the process of the

speedy global diffusion of technology.

Turning to the “Second World”, free capital has been even more damaging in

middle-income countries than in the low-income world (with larger speculative inflows

just providing more potential for crippling capital flight). But more importantly, the

benefits of free trade the Washington consensus promised the middle-income world – and

put into practice by the combination of some big sticks (in the form of IMF

conditionality) and supportive reformist governments – just did not materialize. Instead,

liberalization in the 1980s and 1990s was attended by stagnant growth and rising

inequality, prompting other scholars in addition to me to worry about the world’s missing

middle.41

Ironically given the original focus of the Washington consensus on the region, the

Latin American countries that liberalized have been among the hardest hit by the

flammable combination of high expectations and poor outcomes. It should not be

surprising that 14 of the original 20 developing countries that rose up against the US and

41 See Sutcliffe (2003) and Milanvoic (2003).

56

Europe at Cancun were from Latin America.42 These countries have not benefited from

the trade liberalization embodied in and presided over by the WTO. So why should they

accept the further opening of their economies while the west is unwilling to open its

agricultural markets? Even though the benefits of reduced agricultural protection in the

west are more symbolic than they are real (given the rapidly diminishing importance of

agricultural exports to developing economies), it is easy to see why so many governments

wanted to shout out “enough!” at Cancun.

In sharp contrast with the Latin American experience, the middle-income

countries in East Asia did not take their full dose of Washington consensus medicine.

Yes, export promotion (made possible by government subsidies and low interest loans to

leading edge sectors) continues to be critical to growth in these countries. But capital

controls and relatively high tariffs on imports remain an integral part of the East Asian

model. The old dichotomy between Latin American “import substitution

industrialization” and East Asian “export led growth” was probably overdrawn in the

1970s. The notion that Latin American failures in the 1990s were the result of too little

openness just cannot be sustained; nor can one argue that the continuing successes of

middle-income East Asia have been fueled by an open arms policy to the global

economy.

Supporters of liberalization could respond to the mismatch between the hype and

the reality of globalization in middle-income countries with a plea for patience. Ossified

institutions and cultures take time to change, but the process has begun; just wait, the

benefits will ultimately come. But why have the benefits already flowed to the low-

42 The original G20 developing countries were: Argentina, Bolivia, Brazil, Chile, China, Colombia, Costa Rica, Cuba, Ecuador, El Salvador, Guatemala, India, Mexico, Pakistan, Paraguay, Peru, Philippines, South Africa, Thailand and Venezuela.

57

income world? The answer cannot be that market-supporting institutions are more

developed there.

My reaction is considerably more pessimistic: global markets have placed the

middle-income countries in a no-win trap from which it will be hard to escape. Their

basic strategy in the 1990s was to try to compete with the Chinas of the world by cutting

manufacturing wages. But this ended up only hurting workers’ living standards because

the middle-income countries could not win the low-wage battle in world markets.

The combination of openness announced with great fanfare followed by dismal

outcomes has precipitated widespread populist backlashes in Latin America (as was the

case earlier in the post-communist nations).43 In Mexico, the PRI has been revived if not

reborn as the anti-Fox and the anti-NAFTA. Lula in Brazil and Kirchner in Argentina

both preach of a more assertive role in managing globalization, rather than just

submitting to its logic. The anti-globalist populism of Chavez in Venezuala is

increasingly the rule rather than the exception south of the US border.

Teching-up rather than dumbing-down is clearly the right long run strategy for the

Latin American nations and other middle-income countries. But this will take decades,

not years. And if the East Asian experience is any guide, the process will not be helped

by wholesale openness to global markets – particularly since, unlike East Asia, education

and savings are in short supply in Latin America. Massive investments in physical

43 I have not spent much time talking about the post-communist countries because it is impossible to get accurate information on policies and outcomes in them before the fall of the Berlin wall. But everyone knows that drinking the elixir of markets did not produce the promised magic in the 1990s. Using the same sources as the rest of this article but relaxing the methods somewhat, post-communist countries with lower tariffs grew less quickly (or experienced bigger declines in per capita income), whereas those in which trade increased more quickly experienced faster increases in inequality – just as in Latin America.

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infrastructure, market-supporting institutions and human capital will be required, whereas

the only way to compete with China is to cut wages and to put off the costs of teching-up.

The path to global competitiveness in high value added products will be made

somewhat smoother for the post-communist countries by their imminent accession to the

European Union. But the US is not proposing much more than unalloyed free trade

agreements to the Latin American countries (most of the increases in development

assistance promised by President Bush will go to Africa, for HIV/AIDs among other

things). Certainly, America is unlikely to give Latin American nations preferential access

to its markets.

But the Latin American economies have shown that they can’t compete for US

consumers against exports from China or services outsourced to India, even when they

cut wages. And they cannot hope to compete in the knowledge economy until education

levels, communications infrastructure and property rights regimes come more closely to

resemble those in the US and the rest of the western world. The role for “smart”

development assistance should be clear. But even if the US and other western nations are

willing to supply it, getting the necessary cooperation from governments and citizens

alike will not be easy in countries that have been scarred before by unfulfilled promises

about the benefits of globalization. It is not surprising that Latin American governments

are now pushing for regional economic agreements that seem designed to take care of

themselves (i.e. raise barriers to the rest of the world economy) rather than to push

forward the globalization process faster and further – much to the chagrin of

unreconstructed Ricardians such as Jagdish Bhagwati.

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So this is the world of economic integration as we have experienced it in the first

two decades of the new global epoch. The benefits of market integration are more than

merely theoretical, but on the ground they have also been considerably less than was

promised. The losers – poor people in the west and middle-income countries – are caught

in the crossfire between the stringent demands for success in the knowledge economy and

the harsh realities of competing in low-skilled production against countries where people

will work for much less but can do at least as good a job. This is globalization’s missing

middle. It is critical that the “haves” respond to the concerns of the “have nots”, not only

through compensation and compassion today but just as importantly by helping to

empower them to compete more successfully tomorrow. The stakes could hardly be

higher not only in terms of economic justice but for political stability as well. The simple

refrain from the 1990s that “more markets” will ultimately do the job seems increasingly

unrealistic in the new millennium. What the world requires is political leadership that

understands that while global markets are great for expanding the pie, the negative fallout

of concentrated losses and uncertain futures can only be ignored at our collective peril.