To what extent is globalization or technology responsible for the rise in income inequality observered in most countries over the past two decades?  This is a long running debate which the IMF takes up again in its World Economic Outlook of October 2007. 

Economists get very passionnate about this debate because the last thing they want to do is to pour cold water on globalization.  But it is an awkward one, because two brilliant economists, Stolper and Samuelson, left international trade theory with a theorem that suggests that when advanced countries liberalise trade and/or experience in an increse in imports from a country like China, unskilled workers will be left worse off.

So let's start the story. 

There is plenty to think about because world trade has grown five times in real terms since 1980.  And its share of world GDP has risen from 36% to 55% over this period.  Financial globalization has also grown rapidly as total cross-border financial assets have more than doubled, from 58% of global GDP in 1990 to 131% in 2004.

Income inequality has risen in the advanced countries, and also developing Asia, emerging Europe and the NIEs over the past two decades.  It has declined in sub-Saharan Africa and the Commonwealth of Independent States.  Average real incomes have however increased for all groups and across all regions. 

According to the IMF's calculations, globalization has not been the main factor driving inequality.  Rather, it has been technological progress.  Breaking up this data between advanced and developing countries becomes more interesting.  For the advanced countries, globalisation contributed somewhat more than technology toward to widening income inequality, while technology was the main driver for developing countries.  Surprisingly, within globalization, trade has tended to improve income equality, while financial globalization (especially FDI) has exerted a widening influence on income inequality. 

How could imports from developing countries lead to a reduction in income inequality in advanced countries?  May be as lower-paying manufacturing jobs were by replaced high-paying service jobs?  May be as lower-priced imports from developing countries benefited the poorer segment of the population more than the richer segment (the Walmart effect)?  Regarding FDI, the inequality effect is due to the fact that FDI tends to take place in more skill- and technology-intensive sectors in both advanced and developing countries which inceases the relative demand for skilled workers.  Outward FDI from advanced countries also reduces the demand for relatively lower-skilled workers. 

The finding that investment in technology widens income inequality is consistent with the view that new technology, in both advanced and developing countries, increases the premium on skills.  Among developing countries, the effect of technological progress is stronger in Asia than in Latin America, possibly reflecting the greater share of technology-intensive manufacturing in Asia.      

So, once again, economists and indeed all of us can breath a sigh of relief that globalization is not the main culprit.  Rather, it is technology that is widening the gaps between rich and poor.  Economists hope that this will hose down the anti-globalizers, but it might just encourage the Luddites.

But as the IMF says, it really is more complex than all that.  Even though its statistical work analyses distinct and separate effects of technology, in reality technology and globalization are very closely linked.  Technological advances have helped deepen trade and financial linkages between countries, and globalization has faciliated the spread of technology.  So we cannot be sure of the truth.

As the IMF analysis also shows, education is also an important factor for reducing income disparities.  But with all these recommendations for education and training, when will we have time for fun?

Reference:

IMF World Economic Outlook, October 2007 -- www.imf.org