(This essay was published in the South China Morning Post on 4 October 2017.)
Globalization since the collapse of the Berlin Wall has had both supporters and detractors. Supporters credit it for bringing unprecedented prosperity to many parts of the world in the last quarter 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 figure nicknamed the “Elephant Chart,” produced by former World Bank economist Branko Milanovic, seems to offer dramatic proof of what opponents of globalization have claimed (see Figure 1).
Figure 1 takes the world’s population, lines it up in percentiles from the poorest to richest, and then examines the income growth each percentile achieved from 1988 to 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 superrich – mostly from the mature countries – are much richer 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 in the past.
The dip around the base of the trunk is perceived as showing that incomes of the lower and middle classes in the mature 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, benefitting 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 due to offshoring.
Many have interpreted the “Elephant Chart” as showing that globalization 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 technological advances versus 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 the 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 ex-Soviet and Eastern European countries from the group of mature economies. The result was that the drop to zero around the 80th percentile disappeared. This 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 the back also disappeared, confirming the stellar performance of China alone accounts for the lion’s share of broader gains to emerging market populations.
In summary, there is scant evidence that income has stagnated across the lower and middle classes in all mature countries. The true significance of the “Elephant Chart” is the remarkable rise of the world’s lower and middle classes, especially China, and how global income equality has declined as a result of globalization since the fall of the Berlin Wall.
Deconstructing the “Elephant Chart” leaves us with a new puzzle. If wages of the lower and middle classes did not stagnate in the 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.