First draft Is globalization sustainable?

First draft Is globalization sustainable? by Arne Bigsten GCGD & Department of Economics University of Gothenburg 171025 1

1. Introduction The post-world War II international order has helped to advance peace and prosperity by increasing international exchange and connectedness. It has meant increasingly free trade and movement of capital as well as increasing international migration. This period has seen dramatic economic and social advances in the world, and until recently there has been fairly broad public support for increased openness and integration. However, in Western countries there is now a backlash with increasing hostility against integration and international institutional structures (see Brexit, Trump, Le Pen etc.). There is a risk that this will undermine the structures that have upheld the global system since World War 2. In this paper I discuss what such a backlash might imply for the prospects of development and poverty reduction in the South. I start by showing some data on the income changes we have seen there during the last 50 years, which was a period of extensive globalization. I then review the changes we now see in the world with regard to globalization patterns, followed by some comments on the Northern backlash against globalization. Finally, I discuss what we should do in terms of policy to make it possible for the poorest countries in the world to derive benefits from globalization that can help them reduce the welfare gap relative to the developed counties. 2. Incomes and Poverty in the South The recent half century has been the most successful in human history in terms of increasing incomes and reduced poverty. The imbalance between the Western countries and its offshoots and the rest of the world increased dramatically from the industrial revolution until it peaked in the middle of the previous century (Maddison, 2006). Since then the dominance of the west has declined, and the centre of gravity in the world is moving eastwards. We see in Figure 1 that the gaps between the OECD countries and the rest are still huge, but we also see that during the last decades there are regions that have grown faster than the OECD. This is particularly the case for East Asia with China as the driver. The laggards are South Asia and Sub-Saharan Africa, although the former dominated by India is now growing much faster than previously and much faster than the OECD. The increase in per capita incomes has also led to extensive reduction in poverty levels as measured by the World Bank since 1981 (Figure 2). It seems unlikely that this development would have been possible without the concurrent process of globalization. 2

Figure 1: Per Capita Incomes (constant 2011 PPP USD) 45000 40000 35000 30000 25000 20000 15000 10000 5000 World Sub-Saharan Africa South Asia OECD members Middle East & North Africa Latin America & Caribbean East Asia & Pacific 0 1990 [YR1990] 1992 [YR1992] 1994 [YR1994] 1996 [YR1996] 1998 [YR1998] 2000 [YR2000] 2002 [YR2002] 2004 [YR2004] 2006 [YR2006] 2008 [YR2008] 2010 [YR2010] 2012 [YR2012] 2014 [YR2014] 2016 [YR2016] Source: WDI 2017 Figure 2: Poverty Headcount (Poverty line of 1.90 2011 USD) 90 80 70 60 50 40 30 20 10 0 1981 [YR1981] 1984 [YR1984] 1987 [YR1987] 1990 [YR1990] 1993 [YR1993] 1996 [YR1996] 1999 [YR1999] 2002 [YR2002] 2005 [YR2005] 2008 [YR2008] 2010 [YR2010] 2011 [YR2011] 2012 [YR2012] 2013 [YR2013] World Sub-Saharan Africa South Asia Latin America & Caribbean East Asia & Pacific Source: WDI 2017. Missing data for SSA 1981-1987. 3

3. Is Globalization Losing Steam? Globalization has implied a tighter integration of the economies of the world, and this is reflected particularly in the increasing trade between countries. To a considerable degree this is due both to the increasing importance of the outsourcing of production and the integration of the financial system. The global financial crisis of 2008 was a severe set-back for the globalized economic system and countries turned more inwards. One way to check the degree of economic integration among the countries of the world is to look at export shares of the various regions. Figure 3 shows that there was a significant drop in export orientation across the whole world at that time, which is hardly surprising, but we also see that the trend has not been reversed as yet although economies have gradually returned to more normal conditions. Actually the share of exports in world GDP peaked (after the financial crisis) in 2012 at 30.5%, but then it dropped again to 29.4% in 2015. The drop in the share of exports in GDP in China is even more dramatic from 35.9% in 2007 to 19.6% in 2016 (WDI 2017). Maybe there are other forces apart from the setback due to the financial crisis that is reversing the extent of outsourcing and economic integration? When robots can perform more and more tasks it is maybe becoming less important to outsource production from the developed countries to regions where labour is cheap? There is talk about a reserve army of robots holding down wages in the poor countries. If this is really the case, it might not be feasible for the least developed countries to achieve their economic take-off as the Asian countries did on the basis of cheap labour manufacturing production. This is a very serious worry for Sub-Saharan Africa where they have not yet been able to take this step. 4

Figure 3: Share of Export in GDP 1967-2015 60 50 40 30 20 World WLD Sub-Saharan Africa SSF South Asia SAS Latin America & Caribbean LCN East Asia & Pacific EAS 10 0 1967 [YR1967] 1970 [YR1970] 1973 [YR1973] 1976 [YR1976] 1979 [YR1979] 1982 [YR1982] 1985 [YR1985] 1988 [YR1988] 1991 [YR1991] 1994 [YR1994] 1997 [YR1997] 2000 [YR2000] 2003 [YR2003] 2006 [YR2006] 2009 [YR2009] 2012 [YR2012] 2015 [YR2015] Another major dimension of globalization is foreign direct investment (FDI). Also here there has been a stagnation of magnitudes in relation to GDP. The peak for FDI relative to world GDP was in 2007, when it was 5.4% in 2015 it was down to 2.9% after a slight recovery toward the end of the period. This is also related to the increased caution following the financial crisis. Debt relative to world GDP increased from 180% in 2007 to 220% in March 2017, so there is probably a need for deleveraging. The fall in FDI growth may also reflect an increased scepticism against outsourcing production to poorer and cheaper regions. So overall it seems fair to say that the process of globalization has slowed up, and if improved participation in the global economic exchange is important for growth in the poor countries this is a serious concern. 5

Figure 4: FDI as a share of GDP 1977-2015 7 6 5 4 3 2 1 0-1 1977 [YR1977] 1979 [YR1979] 1981 [YR1981] 1983 [YR1983] 1985 [YR1985] 1987 [YR1987] 1989 [YR1989] 1991 [YR1991] 1993 [YR1993] 1995 [YR1995] 1997 [YR1997] 1999 [YR1999] 2001 [YR2001] 2003 [YR2003] 2005 [YR2005] 2007 [YR2007] 2009 [YR2009] 2011 [YR2011] 2013 [YR2013] 2015 [YR2015] World Sub-Saharan Africa South Asia Latin America & Caribbean Middle East & North Africa East Asia & Pacific OECD members Trade and FDI involve large flows of resources, but what about other resources flows that may matter for poor countries such foreign aid. Figure 5 shows that ODA is nowadays of rather limited magnitudes relative to GDP for developing countries. In most regions the average inflows are less than one percent of GDP, while it is only 3% of GDP in the most aid dependent region, that is Sub- Saharan Africa. Clearly these flows cannot compensate to any high degree for the lack of trade revenues and FDI inflows except in the poorest countries. Remittances are actually a few times larger than ODA flows. Foreign aid can of course contribute in other ways by transferring knowledge etc., even if it is quantitatively less important than earlier also for the poorest countries. The rich countries may also play a major role by helping to devise a system that makes it possible for the poorest countries to link up to the world market. 6

Figure 5: Aid as share of GDP 1967-2015 8 7 6 5 4 3 2 1 0 1967 [YR1967] 1971 [YR1971] 1975 [YR1975] 1979 [YR1979] 1983 [YR1983] 1987 [YR1987] 1991 [YR1991] 1995 [YR1995] 1999 [YR1999] 2003 [YR2003] 2007 [YR2007] 2011 [YR2011] 2015 [YR2015] World Sub-Saharan Africa South Asia OECD members Middle East & North Africa Latin America & Caribbean East Asia & Pacific 4. Northern Backlash The prospects for poor countries to enter the world markets in a major way thus may be held back by structural changes in the global economic system. But this is not their only problem. We also have a situation where there is a backlash against globalisation in the North, which may make poor country access to the global markets harder. This increasing scepticism in the West against globalization has several explanations. Although globalization has improved outcomes on average, there may be groups that have lost out or failed to gain what they see as their fair share. Globalization may have helped reduce the gaps between rich and poor countries, but it may at the same time have contributed to increased inequality within countries. The pattern of income growth that the world has experienced may be illustrated by Branko Milanovic s (2016, p. 11) depiction of how global incomes changed by percentile between 1988 and 2008 (Figure 6). The title of the first chapter in the book sums up its main message well The Rise of the Global Middle Class and Global Plutocrats. 7

Figure 6 The diagram shows that there have been major advances for a broad segment of people between the 15 th of 65 th percentile. These include Asian populations reflecting, for example the rapid growth in Chinese middle class incomes. Further up in the global income distribution we see that the income growth has been much less. This group includes for example the US middle class, which has not seen real wage increases for decades. At the top, however, incomes have grown fast. This is shown by the estimates of the USA by Alvaredo et al (2016) (Figures 7). This is what has sparked the debate about the increasing gap vis-a-vis the top 1 percent. 8

Figure 7 The development has been similar but less dramatic in France, but even more striking is that it has been very pronounced in China (Piketty et al., 2016) (Figure 8). The latter is now more unequal than France. Figure 8 This change in the pattern of incomes has also had far-reaching implications for the distribution of wealth (Alvaredo et al, 2016). We see in Figure 9 that a long historical process of reduction of wealth 9

concentration in the Western economies was reversed around 1980. At the same time we see that the pattern repeats itself also in China. The factors that determine the evolution of the wealth distribution are differences in savings rates across income and wealth groups, differences in labour incomes and returns to wealth as well as the progressivity of income and wealth taxes (Alvaredo et al., 2016). Figure 9 It is the increasing inequality in the North, which risks undermining support for the liberal global order, and generally non-inclusive growth patterns may undermine trust and eventually governance, undercutting policy-makers ability to sustain policies that support high growth (Spence, 2011). At the same time there does not seem to be a similar backlash in the South. In the North we can now see an emerging conflict between one group that puts high priority on solidarity or equity within its own country, and another one that is relatively more concerned about global justice. The former are more sceptical than the latter against free trade, market liberalism, and liberal migration policies. The globalization sceptics tend to be patriotic or nationalistic and put a higher value on national citizenship. 1 1 President Trump is threatening to scrap NAFTA or make it less open. He wants for example to increase the share of a product that is produced in North America in order to enjoy tariff-free trade between the countries involved (in the case of automobiles and parts from 62.5 % to 85 % and with 50% of the value from the US 10

At the same time as there are groups in the West which are concerned about the impact of farreaching globalization on them and therefore are backing political forces seeking to roll it back, there are large groups in developing countries that haven t had the opportunity to become globalized and therefore have failed to benefit from globalization. De Soto 2 argues that there are five billion people in the world who have failed to effectively participate in the global economy. He argues that the integration of these people is a key condition for global justice. So even if we are primarily concerned with global justice and development in the South, we face a double challenge. If we accept that an efficient lifting of poor people in the developing world out of poverty depends on their successful integration into the global economy, we face challenges on two fronts. We need to ensure that the open international system is maintained (and preferably developed further), but this requires the support of the majority of citizens in the rich countries. To maintain this support we need to be concerned about inequalities in the North, which tend to lead to increased anti-globalization attitudes. The second challenge is to seek to make it possible for the poor in the South to get access to the global system and to benefit from this access. To make it possible for the poor countries of the world to catch up we need to be concerned with what growing inequality in the North does to these prospects. 5. Managing Globalization for Development in the South What are the forces currently driving the transformation of the world economy? A couple of decades ago the message was that the new information technology had made it easier to coordinate production activities via the market and that the importance of firm size was declining. Outsourcing via market transactions was growing rapidly. However, recently it seems as if the trend has been reversed and that a process of concentration is underway. Antras and Chor (2013) 3 analyse this issue within a property rights model of firms boundary choices, i.e. the extent of control over different segments of the value chain. They explain how firms organize the global value chains and why it now may be beneficial to do transaction within firm rather than at arms-length distance in the market. The largest corporation in the North now produce an increasing share of GDP. For example, in 1994 the 100 largest firms of the US produced 33% of its GDP, while their share had increased to 46% in 2013! 4 There is a clear process of concentration of control of the global economy, and it is not itself). He wants to limit the number of federal contracts that Mexico and Canada can win, and wants to change the NAFTA dispute settlement procedures (New York Times, 2017-10-12). 2 Hernando de Soto: Globalization for everyone, Project Syndicate September 19, 2016. 3 Antràs, P. and Chor, D. (2013), Organizing the Global Value Chain. Econometrica, 81: 2127 2204. 4 The rise of the superstars, Special report in the Economist, September 17, 2016. 11

inconceivable that this is matched by an increasing concentration of wealth and incomes. This concern has been raised by, for example, Piketty. 5 It seems clear that globalization has contributed to the increasing income concentration by making it possible for firms to roll out their business models globally and thereby reap the benefits of economies of scale. The new global superstars benefit from network economies, which make it possible to reduce costs per unit or increase monopolistic profits by conquering larger and larger market shares. The reaping of excess profits and their allocation probably contributes to increased inequality. The capital share of GDP is on has increased in the North, and Bengtsson and Waldenström (2015) shows that there is a very high correlation between inequality and the share of capital in the national income. Of course, these new giant firms have provided consumers with new and very beneficial gadgets, and one would like to see them continue to do so. But for this to be possible without a public backlash there is a need to seek to control them better in terms of, for example, the payment of taxes. At present some 30% of FDI of global firms flows through tax havens, and they are able to exercise their power in negotiations with governments about rules and regulations. So to maintain the legitimacy of the global economic system, the global firms need to be better controlled and the benefits of the firms needs to be better distributed. For this to be effective there is a need for international collaboration, since the large firms can circumvent national attempts at controlling and taxing them. Such international collaboration (OECD is seeking to enhance tax cooperation) would be beneficial also for the groups in the North who feel left behind. There are, for example, discussions about source-based taxation, but since the supply chains of today are so complex it is hard to know where one should apply it. The idea among globalization sceptics that trade restrictions will help reduce inequality in the North is problematic. For example, in the US the poor will see a much larger fall in real income than the rich, due to the high share of imports in their consumption baskets. 6 And it is also the case that a large share of the inequality increase in the US is driven by the increasing concentration of profits. 7 The increase in wage inequality is also driven by this, since two thirds of it is explained by increasing differences between firms in average wage paid (the profitable firms pay more at all levels), while increased within firms inequality explained only one third. 8 Thus, it seems to be the case that the 5 Piketty, T. (2015), Capital in the 21st century, 6 Pablo D. Fajgelbaum, P.D., Khandelwal, A.K. (2016); Measuring the Unequal Gains from Trade, Quarterly Journal of Economics, 1113-1180. 7 Furman, J., Orszag, P. (2015), A Firm-Level Perspective on the Role of Rents in the Rise in Inequality, Presentation at A Just Society Centennial Event in Honor of Joseph Stiglitz, Columbia University 8 Song, J., Price, D. Guvenen, F., Bloom, N., von Wachter, T. (2016), Firming Up Inequality, Stanford mimeo 12

higher monopolistic rents earned by larger corporations increase inequality by increasing profits and increasing wage inequality. The effective way to combat this is not tariffs but rather to deal with the increase in the market power of the big corporations. Competition agencies have not been effective in countering the process of concentration. When newcomers enter the market the major players tend to buy them before they can compete effectively. So competition policy could be an effective policy measure. There is also a need for an active labour market policy protecting the losers in the structural changes due to globalization. There should also be macroeconomic measures to keep demand up but also structural measures such as re-education. And lastly there need to be safety nets that protect those that cannot come back into the labour market. An international system that controls the multinationals would of course also be important for the countries in the South, who suffer from the transfer pricing and negotiation tactics of MNEs. At the same time the poorer countries need to attract foreign capital and technology to make it possible to close the gap to the North. The outsourcing revolution has essentially bypassed sub-saharan Africa because of its poor institutions and infrastructure and because of its lack of relevant connections to the international markets. This lack of integration is a serious concern, since much of the transfer of technology to the South occurs via FDI and outsourcing. China managed to break into global supply chains on the basis of its cheap labour, and by now it supplies a fifth of global manufacturing exports. Chinese incomes have increased rapidly and hundreds of million Chinese have been lifted out of poverty. The question now is whether other locations with cheap labour such as Sub-Saharan Africa will be able to repeat the Chinese take-off. The situation seems to be that capital goods and automation are getting cheaper, and therefore it will be harder for SSA to break into the global supply-chain economy on the basis of its cheap labour. This is very problematic since about 80 percent of world trade takes place within supply-chains within multinational corporations or organised by them. There is actually a considerable relocation of production back to the North from the South. Most economists support free trade, but there is less unequivocal support for free capital movement. Clearly poor economies need more investments, and foreign investment is one way of getting it. Foreign direct investments are generally beneficial, but it is less clear that short-term capital flows are. There is considerable evidence that surges short-term of short-term capital can cause severe problems in the form of banking or currency crises. 9 9 Ghosh, A., Ostry, J.D., Qureshi, M.S. (2014).Exchange Rate Management and Crisis Susceptibility; A Reassessment, IMF Working Paper 14/11. 13

The international system should be designed in such a way that it becomes easier for poor countries to link up to the world market. At the same time, these countries must get their own economies set up for global integration. The character of such an economy is fairly well known. What is less well understood is how one set up the political and institutional system so that an efficient economy can be developed. 14

References Antràs, P. and Chor, D. (2013), Organizing the Global Value Chain. Econometrica, 81: 2127 2204. Bengtsson, A., Waldenström, D. (2015), Capital Shares and Income Inequality: Evidence from the long run, IZA DP No. 9581. de Soto, H. (2016) : Globalization for everyone, Project Syndicate September 19. Furman, J., Orszag, P. (2015), A Firm-Level Perspective on the Role of Rents in the Rise in Inequality, Presentation at A Just Society Centennial Event in Honor of Joseph Stiglitz, Columbia University Ghosh, A., Ostry, J.D., Qureshi, M.S. (2014).Exchange Rate Management and Crisis Susceptibility; A Reassessment, IMF Working Paper 14/11. Maddison, A. (2006), The World Economy: A Millennial Perspective, OECD Development Centre, Paris. Milanovic, B. (2016), Global Inequality: A new approach for the age of globalization, The Belknap Press of Harvard University Press, Cambridge, Mass. Milanovic, B., Roemer, J.E. (2016), Interaction of Global and National Income Inequalities, JGD 7(1): 109 115 New York Time (2017-10-12), Trump s Tough Talk on NAFTA Suggests Pact s Demise is Imminent. Pablo D. Fajgelbaum, P.D., Khandelwal, A.K. (2016); Measuring the Unequal Gains from Trade, Quarterly Journal of Economics, 1113-1180. Piketty, T. (2015), Capital in the 21st century, Song, J., Price, D. Guvenen, F., Bloom, N., von Wachter, T. (2016), Firming Up Inequality, Stanford mimeo Spence, M. (2011), The Next Convergence: The Future of Economic Growth in a Multispeed World, Farrar, Straus and Giroud. The rise of the superstars, Special report in the Economist, September 17, 2016. 15