The View

Don’t blame globalisation for stagnant wages in rich countries

PUBLISHED : Tuesday, 03 October, 2017, 2:50pm
UPDATED : Tuesday, 03 October, 2017, 10:52pm

Globalisation, since the collapse of the Berlin Wall, has had both supporters and detractors.

Supporters credit it with bringing unprecedented prosperity to many parts of the world in the last quarter of a century and lifting 650 million people out of poverty. Detractors blame it for the slow income growth afflicting low- and middle-class workers in rich countries.

Within economic policy circles, a graphic illustration nicknamed the “elephant chart” produced by former World Bank economist Branko Milanovic seems to offer dramatic proof of what opponents of globalisation have claimed (see chart).

The chart takes the world’s population, lines it up in percentiles from the poorest to richest, and then examines the income growth each percentile achieved in the 20 years between 1988 and 2008 in the same way Milanovic did. The elephant’s hump-shaped back shows the rise of China, where hundreds of millions have seen huge improvements in living standards.

The tip of the elephant’s trunk, at the far right, shows that the world’s super-rich – mostly from the mature countries – are much wealthier than in the past. The tail at the far left shows that the world’s poorest – mostly from Africa – are only slightly better off than they used to be.

It is hard to imagine how free trade and investment flows could have led to the stagnation of living standards for the bulk of people in rich countries

The dip around the base of the trunk is perceived as showing that the incomes of the lower and middle classes in advanced countries, including the United States, have stagnated.

Professor Richard Baldwin, in his new book The Great Convergence, describes the process underpinning these outcomes. His thesis is that the information and communications technology revolution allowed manufacturing (and even some service) production to be offshored to take advantage of low wages in poor countries, thereby benefiting hundreds of millions who were living in poverty.

On balance, the mature countries still gained. The offshoring process made many businesses there very profitable, and consumers all gained from lower priced imported products that were now manufactured in the low-wage countries. However, some workers lost their jobs because of offshoring.

Many have interpreted the elephant chart as showing that globalisation helps poor countries to grow at the expense of the lower and middle classes of mature countries. But when it comes to manufacturing-job losses in mature countries, economists who have studied the situation give greater importance to the technological advances that enabled offshoring to explain the losses.

A lot of other things also happened between 1988 and 2008. The Soviet Union fell and Japan stagnated. China shifted from a state-run economy to private-sector growth. The Reagan and Thatcher tax cuts and deregulation ushered in new sources of growth and so did new technological innovations. It is hard to imagine how free trade and investment flows could have led to the stagnation of living standards for the bulk of people in the rich countries. These are not zero-sum games.

Economist Caroline Freund devised a simple way to understand what groups are responsible for the shape of the elephant chart by removing Japan and the former Soviet and Eastern European countries from the group of mature economies. The result was that the drop to zero around the 80th percentile disappeared. That means it is not the lower and middle income earners in rich countries that are pulling the line down, but Japan and the poorly performing former Soviet bloc.

As for the elephant’s rising back, when China was removed that also disappeared, confirming that the stellar performance of China alone accounts for the lion’s share of broader gains in emerging market populations.

In summary, there is scant evidence that income has stagnated across the lower and middle classes of all mature countries. The true significance of the elephant chart is the remarkable rise of the world’s lower and middle classes, especially China’s, and how global income equality has declined as a result of globalisation since the fall of the Berlin Wall.

But deconstructing the elephant chart leaves us with a new puzzle: if the wages of the lower and middle classes did not stagnate in mature economies, then what explains Brexit, the rise of Trump and xenophobia in many of these countries? An examination of data on income inequality and per capita GDP growth rates among the mature economies further confirms that there is indeed no correlation. This suggests other factors are largely responsible for these developments.

Richard Wong Yue-chim is the Philip Wong Kennedy Wong Professor in Political Economy at the University of Hong Kong