(This essay was published in Hong Kong Economic Journal 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 problems of 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).
This chart shows graphically how the incomes of the world’s richest people – the top 1 per cent – grew sharply over the period 1988-2008. It further shows how the incomes of the world’s former poor – mainly the Chinese – grew sharply over time to become the world’s middle class today.
The chart also identifies a group caught between the world’s rising middle class and the top 1 per cent where incomes have stagnated. This latter group has been identified as the low and middle classes of mature economies like the United States.
But, while the elephant diagram is correct in showing that the top 1 per cent of the world’s richest people and the world’s former poor have both advanced, the common interpretation that mature countries lost ground because of globalization is misguided.
Paul Krugman, for example, has used the chart to argue that globalization allowed poor countries to grow to the detriment of workers in mature countries. Trump has made such a view the centerpiece of his America first political rhetoric. This line of reasoning is flawed.
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.
The huge income growth for a large share of the world’s population in poor countries is the human side of what was described by Professor Richard Baldwin in his new book The Great Convergence. 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.
The offshoring process made many businesses in the mature countries very profitable. Some workers in the mature counties lost jobs that were offshored. Consumers, however, all gained from lower priced imported products that were now manufactured offshore in the low wage countries. On balance, the mature countries still gained.
Still, not every company in the mature countries decided to or was successful in offshoring production overseas. Many businesses stayed at home but also cut less-skilled jobs because of technological advances. Globalization, therefore, does not account for all of the lost less skilled jobs in the mature countries.
Manufacturing jobs lost in the mature countries resulted from a combination of both technological advances that reduced the demand for less-skilled workers and the offshoring of production to low-wage countries. Economists who have estimated the relative importance of technological advance versus offshoring have found that the latter effect was usually of less importance.
For the world as a whole, globalization has reduced global inequality sharply within a very short period of time. It is by no means obvious that it has increased inequality within each of the mature countries as a consequence. But many have interpreted the “Elephant Chart” as showing globalization helps poor countries to grow at the expense of the lower and middle classes of mature countries.
A problem with this interpretation is that a lot of things 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” and to examine how its shape changes when various countries are removed. Figure 2 shows the income gains over the period 1988-2008 for two groups of countries: (1) Japan, the ex-Soviet and Eastern European countries, and (2) the mature economies excluding Japan, the ex-Soviet and Eastern European countries.
The incomes of most people in the first group declined or stagnated over the period (see Figure 2). Japan stumbled largely from demographic change, while the ex-Soviet and Eastern European countries experienced political and economic disruption when the Soviet Union collapsed.
When Japan and the ex-Soviet and Eastern European countries are removed from the group of mature economies, the drop to zero around the 80th percentile disappears. This shows that it is not the low- and middle-income population in all the rich income countries or even the United States that pull the line down to near zero around the 80th percentile. Rather, it is Japan and the poorly performing ex-Soviet and Eastern European countries.
If China is further removed, then the elephant’s back also disappears (Figure 3). This shows the stellar performance of China alone accounts for the lion’s share of broader gains to emerging market populations.
It also shows that most of the world’s population has seen income gains of around 40 per cent with the exceptions of the top and bottom of the distribution. In summary, there is scant evidence that income stagnated across the lower and middle classes in all mature countries while the incomes of the populations of the poor countries soared.
If incomes of the lower and middle classes in the mature countries have not stagnated, then blaming globalization for something that did not happen simply makes little sense. The true significance of the “Elephant Chart” is about 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 the mature 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, suggesting other factors are largely responsible for the changes.