Inequalities, National and Global

by Joseph Joyce

Inequalities, National and Global

The publication of Thomas Piketty’s Capital in the Twenty-First Century brought attention to an issue that has been slowly seeping into public discourse. President Obama’s State of the Union address made it clear that we will not need to wait until the 2016 Presidential campaign to hear proposals to rectify the rise in inequality. But the data and trends of global inequality reveal a more complex situation than the national states of affairs that Piketty highlights.

Inequality is often measured by the Gini coefficient. This number is based on the Lorenz curve, which shows the proportion of the total income of a population that is cumulatively earned by different segments of the population, beginning at the bottom. The Gini coefficient (or index) is the ratio of the area under an actual Lorenz curve distribution of a society and the area of the distribution of perfect inequality. It is a number between zero and one (or 100), where zero corresponds to a case of perfect equality, and one is a situation of total inequality. A Gini coefficient above 0.50 is considered to be “high.”

We can compare Gini coefficients across countries and regions. Nations in Europe have Gini indixes between 0.24 and 0.36, while the comparable figure for the United States is 0.36. The coefficients are usually higher in middle- and lower-income nations; the average for Latin America and the Caribbean, for example, is 0.48, and for sub-Sahara Africa it is 0.44.

We can also look at how Gini coefficients change over time. What would we expect? The Kuznets curve, a concept based on the work of economist Simon Kuznets, predicts a rise in inequality within nations as they develop economically. The Gini coefficient would rise as workers move from low-productivity agricultural jobs to the industrial sector where wages are higher. But as a society matures and the agricultural sector shrinks, the gap between urban and rural workers should decline, and inequality fall.

The actual historical patterns, however, have been different. Inequality has been on the risewithin many nations at high levels of inequality. Piketty claims that such inequality is a basic feature of capitalism, and will only worsen over time. His thesis is based on the relationship between the rate of return on capital, r, which includes profits, dividends, and interest, and the rate of economic growth, g. Piketty claims that when r > g, wealth accumulates quickly and the incomes of the richest members of society grows faster than those of the middle- and lower-classes.

This trend became strong in England, France and the U.S. in the 19th century. However, it was interrupted during the 20th century by the two World Wars and the Great Depression. Goverments intervened within their economies to improve the position of the poorest members, and the economic growth of the 1950s and 1960s reduced the importance of inherited wealth. But today, Piketty argues, we are returning to a world where economic growth is stagnating, and the rate of return on capital exceeds the economic growth rate. Unless governments intervene again, the result will be – and already has been – a return to the levels of inequality of the 19th century.

But there is another way of measuring inequality: not within nations but on a global basis. This has been done by, among others, economist Branko Milanovic. He points out that there are different ways of doing this. One method is to treat each country as a unit of observation, using the  average income of each nation. We can plot a Lorenz curve with all the countries for which there are data, and then calculate the corresponding Gini coefficients over time. If this method is used, there is little movement in the international Gini coefficient between 1960 and 1980. But during the period beginning in the 1980s through 2000, the international Gini coefficient rises. Richer countries grew faster than did the poorer ones, thus reinforcing inequality. This is the period when international trade and finance began to grow most quickly, and the observed trend would indicate that globalization rewarded the rich.

But if each country is treated as a single unit, we ignore the fact that some countries are much bigger than others. When countries are weighted by their population, a different phenomenon is observed: during the period that began in the 1980s, the international Gini coefficient falls, and has continued to do so over time. Why the difference? China and India had rapid economic growth during this period. Since they are countries with large populations, there was a decline in global inequality using population-weighted Gini coefficients during the period of increased globalization.

We can demonstrate this trend using a perspective that transcends national borders. Milanovic points out that If we arrange the world’s population by income regardless of national origin, we can calculate a global Gini coefficient. There are not many years of data available to do this calculation, but the trend that is observed shows that this global Gini coefficient has dropped.

Christoph Lakner and Milanovic showed this phenomenon another way, using global income data from 1988 to 2008. They calculated the rise in income for each decile of the world’s population. They observed the largest gains for the global top 1%, consistent with Piketty’s observations. But they also saw large gains for the the groups in the middle, most of whom were from Asia. This global perspective shows us that Piketty is correct in showing the growth in inequality within nations. But on a global basis there are some interesting movements across people in different nations.

Is there something about globalization itself that has led to these changes? There have many studies that compared the performance of countries that have opened their economies to international trade and finance with those that did not. Some of these studies also looked at the impact of globalization on the poorest members of society.

David Dollar and Aart Kraay, economists at the World Bank, compared the record of two groups of countries that they called globalizers and non-globalizers. The globalizers were those countries which had the largest growth in international trade between the 1970s and the late 1990s. They found that the globalizer nations grew more quickly than the non-globalizer nations. They also tested the effect of this economic growth upon the poor within these nations, and found that the increases in national income were reflected in increases for the poorest group. The authors concluded that open trade regimes lead to faster growth and poverty reduction in poor countries.

However, their conclusions have been challenged. One line of criticism has pointed out that openness to trade may be a result, not a cause, of rapid growth. Recent work on globalization and inequality shows a more complicated picture. A study by IMF economists Florence Jaumotte, Subir Lall and Chris Papageorgiou found that the rise in inequality within developed and developing countries is largely due to technological change, which primarily benefits those with education at the expense of those without education. These authors claimed that the impact of globalization on inequality has actually been relatively minor. Increased trade tends to reduce income inequality because of cheaper food imports, but more foreign investment leads to higher inequality because of the impact of foreign investment on the wages of skilled workers in both developing and developed countries: the more-educated workers gain while those less-educated fall behind. They concluded that the best remedy for increased inequality is more educational opportunities.

The situation we face today is complicated. On the one hand, inequality within nations has risen. On the other hand, inequality across borders may have fallen. Many are concerned that continued inequality might hinder growth. If those at the bottom of the income ladder do not participate in the benefits of globalization, then economic growth will be stunted. How to promote growth while ensuring that its benefits are shared by all is one of the most significant challenges facing nations today.

crossposted with Capital Ebbs and Flows