What is Globalization?

Of course poverty is affected by many factors other than growth. For example, poverty may increase even where there is growth, because there is an increase in inequality. Gaining a deeper understanding of other influences on poverty, including changes in inequality, is a vital task for research. However there is no reason to think that the beneficial effect of growth on poverty reduction will be systematically offset by increases in inequality. 
Figure 2 shows the lack of any systematic association between growth on the one hand and changes in inequality (measured by the Gini coefficient) on the other for a large sample of countries over several decades. The widespread fear that in poor countries growth must come at the expense of equity is not supported by the facts. The evidence also suggests that the positive link between overall growth and incomes of the poor has not changed in recent decades, when globalization was more pronounced, than in earlier ones when it was less so. 
More open trade raises per capita incomes - and the incomes of the poor 
There is a growing consensus in empirical studies that greater openness to international trade has a positive effect on country per-capita income. (Figure 3. Trade openness in the figure is adjusted to remove the influence of geographical factors.) A recent study by Frankel and Romer (1999) estimates that increasing the ratio of trade to GDP by one percentage point raises per-capita income by between one-half and two percent. Numbers of other studies reach similar conclusions, though the estimated size and statistical significance of the effects vary. (See for example, Edwards (1998) or, for a more skeptical assessment, Rodrik (1999).) 
These results are consistent with economic theories about the effects of international trade going back at least 200 years. The oldest and most widely agreed is that trade lets an economy make better use of its resources, by allowing imports of goods and services at a lower cost than they could be produced at home. In particular trade enables developing countries to import capital equipment and intermediate inputs that are critical to long run growth, but which would be expensive or impossible to produce domestically. From this perspective exports are the price the economy pays to get access to these valuable imports. Other possible benefits include more intense competition, which obliges local firms to operate more efficiently than under protection, and greater awareness of new foreign ideas and technologies. 
What of the impact of freer trade on the incomes of the poor? As noted above, recent work suggests that higher average incomes in a country are generally associated one-for-one with higher incomes of the poor. The same work finds that this link applies to income increases caused by more trade: in other words, the impact of trade on the income of the poor is generally the same as that on per-capita incomes. Thus, for example, a 10 percent increase in the trade to GDP ratio could ultimately raise per-capita income by 5 percent (cautiously taking the lower bound of the estimates by Frankel and Romer), and one would in general also expect a 5 percent rise in the income of the poor. 
But it is important to underline that there is nothing guaranteed about this outcome. Many other factors can influence both growth and poverty. Further, the success of a trade opening is itself often affected by the macroeconomic climate, the quality of institutions and other factors. 
Improving the payoff from trade opening, minimizing unemployment 
Trade liberalization 'works' by encouraging a shift of labor and capital from import-competing industries to expanding, newly competitive export industries. The unemployment caused by trade opening is therefore expected to be temporary, being offset by job creation in other sectors of the economy. The loss of output due to this transitional unemployment (called the social adjustment cost of trade opening) is also usually expected to be small relative to long run gains in national income due to opening. Or, put another way, these adjustment costs are expected to be small compared to the costs of continued economic stagnation and isolation without opening up. 
The limited amount of existing empirical work on the employment effects of trade liberalization in developing countries broadly confirms these expectations. (See World Bank, 1997; Matusz and Tarr, 1999). Nevertheless, while adjustment costs are usually small in relative terms, they can still be a serious issue in many countries because they are often concentrated in a geographical area or in a few industries. They will also tend to be felt 'up front', while benefits will tend to be spread out over future periods. Carefully designed social-safety net and educational or retraining programs to help the most vulnerable affected groups are thus an important complement for trade reforms in many cases. 
The potential costs of trade opening can also be either reduced or worsened by the overall context of policies in which reform is undertaken. High macroeconomic instability (big fiscal deficits, high and volatile inflation, volatile real exchange rates) can aggravate the unemployment costs of trade opening by fostering uncertainty, which can prevent firms from investing in the export sectors that are supposed to create new jobs. 
A premature capital account liberalization in a country with large fiscal deficits can have a similar effect, by inducing large capital inflows, causing the country's exchange rate to rise, thus making its exports uncompetitive. The collapse of structural reforms in the 'Southern Cone' countries of Latin America at the end of the 1970s is partly attributed to this kind of inappropriate sequencing of reforms. Extremely stringent job security regulations may prevent firms hit by import competition from laying off workers, driving them into bankruptcy, as appears to have been the case in Peru in the 1980s. 
References 
Dollar, David and Aart Kraay. (2000). Growth is Good for the Poor. World Bank. (Processed.) 
Edwards, Sebastian. (1998) Openness, Productivity and Growth: What Do We Really Know? The Economic Journal. March 1998. 
Frankel, Jeffrey A. and David Romer. (1999). Does Trade Growth Cause Growth? American Economic Review. June, 1999. 
Matusz, Steven J., and David Tarr. (1999). Adjusting to Trade Policy Reform. World Bank Policy Research Working Paper 2142. 
Rodrik, Dani. (1999) The New Global Economy and Developing Countries: Making Openness Work. 
World Bank. (1997). Global Economic Prospects and the Developing Countries 1997. 
World Bank. (2000). Global Economic Prospects and the Developing Countries 2000. 
This series of World Bank Briefing Papers looks at how to define globalization and then assesses three leading questions about globalization by looking at the evidence from a large number of countries. Is globalization increasing world poverty? Is it worsening world inequality, perhaps by destroying jobs and lowering wages among the poor and unskilled? Is it causing deterioration in environmental standards? These papers concentrate on the international trade dimension of globalization. Subsequent Briefing Papers will look at other dimensions and questions about globalization, including the impact of foreign investments by multinational corporations, and of other capital market flows to developing countries.
April 2000, PREM Economic Policy Group and Development Economics Group 
 
Does More International Trade Openness Worsen Inequality? (Part 3 of a four part series) 
"Globalization is leaving perilous instability and rising inequality in its wake...it has dramatically increased inequality between and within nations......"
-Jay Mazur, Foreign Affairs, January/February 2000
Does globalization worsen inequality within countries? 
Does freer trade increase income inequality within countries, perhaps sufficiently to offset any benefits to the poor from higher overall per capita income? Figure 4 suggests that there is no simple association between changes in trade openness and changes in inequality. Certainly there are many well known cases of countries where inequality has risen as they became more integrated into the world economy. Wages of high school educated males in the U.S. fell 20 percent between the mid 1970s and mid 1990s. 
Income inequality increased in countries such as Argentina, Chile, Colombia, Costa Rica and Uruguay after they liberalized trade at different times in the last three decades. China, one of the fastest integrating countries, also experienced one of the largest increases in inequality, although growth was fast enough to still massively reduce poverty. 
But, as Figure 4 suggests, there are also about as many cases where inequality fell with more trade openness. (This is another way of presenting the fact noted in the discussion of trade and poverty, that in general more trade openness raises incomes of the poor as much as per capita incomes.) 
It has to be said that our knowledge of what factors systematically influence income distribution is extremely limited. Nevertheless, the lack of any systematic empirical association between trade opening and changes in inequality across countries is quite consistent with standard theory. This suggests that trade opening will tend to increase demand for the factor of production that is relatively abundant in the liberalizing country, but scarce in the outside world, thereby increasing its wage. Conversely, opening will cut the wage of the factor that is relatively scarce in the country but more abundant in the world. This theory is consistent with the US experience, where the wages of skilled workers (relatively abundant in the US, more scarce elsewhere) rose relative to wages of unskilled workers (abundant in the outside world.) But it is also consistent with the experience of some East Asian countries, with relative abundance of unskilled workers, where distribution became more equal. Thus one would expect to see the lack of any pattern in Figure 4. (And of course there are many cases that fail to meet the predictions of the simple theory altogether.) 
Much more importantly, trade liberalization is also not the only factor that may be expected to influence the demand for factors of production, and hence their incomes. Other potential factors include technological change, investment patterns, changes in relative productivity, or changes in institutional conditions, for example the declining importance of trade unions, or changes in the implicit contract between workers and employers. In the US, the most intensively studied country, most studies typically attribute only a small part of the fall in low-skilled wages to the influence of trade. (See for example, Burtless et al (1998) or Collins (1996), who concludes that trade and immigration together account for up to 2 percentage points of an 18 percentage-point rise in wage inequality) These studies typically conclude that technological change was a much bigger factor. 
Policies to help the vulnerable deal with economic change 
Though researchers differ about how far they attribute changes in demand for different groups of workers to international factors, most agree that restricting foreign trade and investment would be a very costly means of assisting affected workers. More direct forms of assistance that help workers adapt to new forms of work and acquire new skills are preferable. Facilitating this transition requires lifelong access to education, training and retraining for all workers. Safety nets based on cushioning workers during temporary periods of unemployment and a return to the same job are becoming increasingly outdated. 
Instead, workers need to be empowered to adapt to constant economic change, to succeed in multiple career paths and to choose periods of self employment. The development of efficient capital markets allows individual workers to build financial assets and independence, facilitating the movement between jobs and protecting incomes in times of crisis. Similarly, portable pensions, healthcare and other services will increasingly become part of the worker protection structure. Finally, policymakers need to foster productivity growth as this is the key driving force behind rising wages. Suitable policies include investment in research and development, efficient capital markets (particularly for venture capital) and high levels of education and training. 
Has globalization increased inequality between countries? 
The distribution of per-capita income between countries has become more unequal in recent decades. For example, in 1960 the average per-capita GDP in the richest 20 countries in the world was 15 times that of the poorest 20. Today this gap has widened to 30 times, since rich countries have on average grown faster than poor ones. Indeed, per capita incomes in the poorest 20 countries have hardly changed since 1960, and have fallen in several. But greater openness to trade is unlikely to explain why poor countries on average grew less quickly than rich ones, since, as noted above, openness fosters higher not lower incomes. On the contrary there is some evidence (Ades and Glaeser, 1999) that greater trade openness has tended to reduce inequality between countries. Figure 5 shows that while rich countries have on average grown faster than poor ones, poor countries that are open to trade have grown slightly faster than rich ones, and a lot faster than poor, closed countries. 
One can also adjust information on the distribution of income across countries to reflect differences in their population. This is important because some poor countries with very large populations (China, Indonesia) have grown very rapidly. Thus the relative standing of large groups of people in developing countries has improved even as the relative standing of many countries has declined. The distribution of income between countries adjusted for population shows little significant change over the last couple of decades, with some studies showing modest increases in inequality, and some modest decreases.

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