The global economy has changed dramatically over the past two decades. World trade has grown fivefold since 1980, and its share of world output has risen from 36 percent to 55 percent. Trade integration accelerated in the 1990s as the former communist countries entered the global trading system and developing countries in Asia dismantled trade barriers. The globalization of financial flows has also been rapid. Total cross-border financial assets more than doubled as a share of output between 1990 and 2004, from 58 percent of global GDP to 131 percent. The advanced economies continue to lead the trend in financial integration, but other regions are beginning to catch up.
How have these developments affected people’s incomes and the gap between the rich and the poor within countries? A chapter in the IMF’s October 2007 World Economic Outlook, titled “Globalization and Inequality,” offers some tentative answers.
Using newly available data, our research shows that inequality (measured using the Gini coefficient) has risen over the past two decades in most regions, including developing Asia, emerging Europe, Latin America, and the newly industrialized economies of Asia, as well as in the advanced economies. In contrast, it has declined in sub-Saharan Africa and the Commonwealth of Independent States.
The issue: Is there a link between the increase in inequality seen in most countries over the past two decades and the unprecedented integration of the world economy?
The evidence: Technological advances have made the biggest contribution to widening income inequality. The contribution of globalization is less important. Whereas trade globalization has helped reduce inequality, financial globalization—in particular foreign direct investment (FDI)—has tended to increase it.
Policy considerations: Better access to education and training would help ensure that the increase in incomes fostered by globalization is shared more equally. Policies that broaden the access to finance of the poor would also help, as would further trade liberalization.
The great divide
Technological progress has contributed the most to widening income inequality.
Source: IMF staff calculations.
Most people are better off
Despite this observed rise in inequality, per capita incomes have risen across virtually all regions for all segments of the population, including the poorest. As a result, the poor are now better off in absolute terms, although in most cases incomes have risen at a faster pace for those who are already better off.
What is contributing to the widening of the income gap within countries? Our analysis yielded four main findings.
First, the main factor driving the recent increase in inequality across countries has been technological progress (see chart). This factor alone explains most of the increase in the Gini coefficient from the early 1980s, supporting the view that new technology, in both advanced and developing countries, increases the premium on skills.
Second, globalization has had a much smaller effect relative to technological change, reflecting the opposing influences of trade and financial globalization on inequality.
Third, contrary to common belief, trade globalization has helped reduce inequality rather than increase it. In developing countries, both rising agricultural exports and tariff liberalization have contributed to improving income distribution. In advanced economies, rising imports from developing countries are associated with declining income inequality, presumably through the substitution of lower-paying manufacturing jobs with higher-paying service sector jobs.
Fourth, FDI has had a mainly negative effect on the distribution of income. Higher FDI inflows have increased the demand for skilled labor in developing countries, whereas outward FDI in advanced economies has reduced the demand for lower-skilled workers in these countries.
What do these findings imply for policymakers? Technological change and FDI are associated with higher incomes and should therefore be encouraged rather than suppressed. But because they increase the returns on acquiring skills, we believe increased access to education and training is the key to sharing the fruits of economic growth in a more equitable way.
Florence Jaumotte and Subir Lall
IMF Research Department