Does Trade and Financial Globalization Cause Income Inequality?

• Author: Chris Papageorgiou
• Pages: 1-6

Page 1

The global economy has changed dramatically over the past two decades. World trade has grown fivefold since 1980, and its share of world output has risen from 36 to 55 percent. Trade integration accelerated in the 1990s as the former Eastern bloc countries entered the global trading system and developing countries in Asia progressively dismantled trade barriers. The globalization of financial flows has also been rapid. Total cross-border financial assets more than doubled as a share of output between 1990 and 2004, from 58 percent to 131 percent of global GDP. The advanced economies continue toPage 2 lead the trend in financial integration, but other regions are beginning to catch up. How have these developments affected people's incomes and the gap between the rich and the poor within countries?

The debate on the distributional effects of globalization is often polarized between two points of view. One school of thought argues that globalization leads to a rising tide of income that raises all boats. Hence, even low-income groups come out as winners from globalization in absolute terms. The opposing school argues that while globalization may improve overall incomes, the benefits are not shared equally among the citizens of a country, with clear losers in relative and possibly even absolute terms.¹ Moreover, widening income disparities may not just raise welfare and social issues, but may also limit the drivers of growth, as the opportunities created by the process of globalization may not be fully exploited (Birdsall, 2006; World Bank, 2006).

While there is by now a well developed and extensive body of work investigating the effects of globalization on growth and volatility,² there has been less attention to the potential effect of globalization on income inequality. Jaumotte, Lall, and Papageorgiou (2008) aim to fill this gap by examining the impact of both trade and financial globalization, whereas the existing literature has focused only on trade, with little attention paid to financial globalization (exceptions are Behrman, Birdsall and Székely, 2003; Claessens and Perotti, 2007). The cross-country analysis employs a new dataset on income inequality-based on Chen and Ravallion (2004, 2007) and Luxemburg Income Studies datasets-that produces greater methodological consistency in survey-based inequality measurements across countries and over time.

The analysis of the available data by Jaumotte, Lall, and Papageorgiou (2008) yields two main conclusions. First, the main factor driving the recent increase in inequality across countries has been technological progress. Technological progress alone explains most of the increase in the Gini coefficient from the early 1980s, supporting the view that new technology, in both advanced and developing countries, increases the premium on skills and substitutes relatively

Second, globalization has had a much smaller effect relative to technological change, reflecting the opposing influences of...