How Does Globalization Affect Income Inequality within and Between Countries?

The rise of globalization brought many questions and, at times, even protests. More recently, that noise has faded. The increasing interconnectedness of economies, cultures, and populations has become a defining feature of contemporary society.

But questions are being asked again. Globalization has once again emerged as a lightning rod for criticism. This has been particularly loud when voiced by populist movements in Western societies. These movements have often fused globalization and immigration as convenient scapegoats for economic hardships faced by their nations’ low and middle classes.

Do these opponents of the global order have a valid point? Is there a hint of truth in their criticisms?

This discussion focuses on the impact of globalization on income inequality, both within and between countries. While populist rhetoric frequently draws a direct line between globalization and rising income inequality, it is crucial to delve deeper and understand the broader economic dynamics.

Globalization and Income Inequality – An Overview

In this piece, when I refer to globalization, I am referring to the process by which the businesses and people of nations worldwide become increasingly interconnected.

There are some key pillars to this process.

The first is trade. This is visible in the movement of physical goods at the ports that serve as the start and end points of the vast network of global shipping lanes. It is less visible in the exchange of services people provide at different global points.

Closely related to the flow of trade is the flow of people via legal and illegal migration. People move across borders to access better or differentiated education options, job opportunities, and living conditions when subjectively compared to their point of origin.

The third pillar is the movement of money. Capital flows facilitate the movement of financial assets and investments across the entire span of the global economy.

The final pillar is the diffusion of technology via innovation and technological advancement. Each of the above pillars plays some role in facilitating this final pillar, whether it is bright engineers relocating from one part of the world to another to pursue novel research or capital allocated from one part of the world to another to pursue competitive advantage in a specific field.

Of course, along with globalization’s known benefits come its known drawbacks. One of the most pressing and emotive is income equality. Income inequality refers to the uneven income distribution within a country (intra-country inequality) and between countries (inter-country inequality). The Gini coefficient and income distribution percentiles give us the tools to quantify it.

Does globalization exacerbate or mitigate income inequality? Critics, who often include political populists, argue that globalization leads to job losses, wage stagnation, and a concentration of wealth, particularly in developed countries. Proponents of a globalized world contend that globalization drives net economic growth, reduces poverty, and promotes income convergence between developed and developing nations.

What appears increasingly clear now is that both sides are right. Critics are right that globalization leads to job losses and concentration of wealth within some nation-states. The experience of Western nations across the last generation has borne this out. But, proponents are also correct that globalization drives net economic growth and reduces poverty. However, these benefits accrue primarily in developing nations where incomes are lower, and each net dollar earned via the benefits of globalization can have a more meaningful impact on the quality of life of the person earning it.

A simple example bears this out. According to World Bank data, the average per capita income in the United States is $59,000. A wage increase of $1,000 per annum might be welcomed, but it would be unlikely to have a life-changing impact on the recipient. However, the same wage rise to a worker in Fiji, Ukraine or Guatemala would represent a 25% increase in purchasing power. That relative increase would allow that worker to make some life-altering decisions.

Populist Rhetoric and Globalization

It is self-evident that populist movements have gained traction across many Western countries. These movements thrive on widespread dissatisfaction with economic conditions, appealing to those marginalized by rapid economic changes.

In this environment, populist rhetoric often targets globalization and immigration and attributes many of the economic challenges faced by local populations to these forces. This narrative simplifies complex economic issues and provides a clear target for public frustration. Importantly, it resonates with those who feel left behind by their circumstances.

There is an observable correlation between globalization and the stagnation or decline of purchasing power among many developed countries’ low and middle classes. Even one of the mainstays of the post-World War 2 economic order, the International Monetary Fund, readily admits this. Outsourcing of production, technological changes, and increased global competition are often cited as factors contributing to job losses and suppressed wages. These dynamics have led to a perception that globalization directly harms domestic economic conditions. In turn, this becomes the kindling ignited with varying degrees of success by national populists to make their electoral pitches to voters.

However, correlation does not imply causation. Factors beyond globalization also influence the stagnation of purchasing power. Independent of globalization, technological advancements can displace jobs and alter wage structures. Domestic policy decisions on taxation, labor rights, and social safety nets significantly shape income distribution. The inherent mechanisms of capitalism, such as the drive for profit maximization and shareholder value, impact wage growth and employment conditions.

So, as ever, the truth is complex. However, the line that globalization lowers living standards in the West contains enough truth. It resonates with the experience of enough citizens to be a compelling argument about why local living standards have changed while those offshore have improved.

Economic Trends in Globalization

Despite severe stress tests such as the pandemic, globalization has remained entrenched. Economic integration, facilitated by technological advancements and trade agreements, has expanded markets and interconnected economies globally.

Concurrently, global immigration has been driven by demographic shifts, labor market demands, and humanitarian considerations. In many Western countries, immigrants contribute to economic growth, fill essential labor shortages, and bring diverse skills and perspectives to their host economies.

Despite the benefits of globalization and immigration, there has been a noticeable correlation with the stagnation or decline of purchasing power among the low and middle classes in many developed countries. This correlation can be attributed to several factors, including:

• Job Displacement. Globalization has led to outsourcing and automation, which have displaced certain jobs and contributed to wage stagnation.
• Income Inequality. The benefits of economic growth driven by globalization have not been evenly distributed, leading to widening income gaps.
• Cost of Living. While globalization has lowered prices for some goods, essential costs such as housing and healthcare have often outpaced wage growth.

Beyond Globalization – The Role of Capitalism

Globalization is often blamed for rising income inequality. However, a deeper examination reveals that the broader issue lies in the functioning of contemporary capitalism and free markets. The structural changes within these systems have profound implications for income distribution and economic disparity.

The “profit trap” concept highlights how the relentless pursuit of profit maximization can lead to adverse economic outcomes. This might be understood as capitalism untethered from community standards or the morals of the men and women making decisions.

A symptom of this is companies increasingly prioritizing short-term profits over long-term investment in human capital and equitable growth. A recent example of this approach is the travails of the once-great Boeing, which was admired for its engineer-led culture and focus on precision and excellence. That reputation is in tatters after a long period of ‘profit trap’ led thinking that resulted in hundreds of deaths and hundreds of millions of dollars worth of fines.

There are also accepted practices within modern capitalism that contribute to rising inequalities. The emphasis on shareholder value often comes at the expense of workers’ wages and job security. Automation and technological advancements, while driving efficiency, can displace workers and create a skills gap. Each of these places additional pressure on equally distributed income within countries and is a tailwind to locally-based income inequality as higher-skilled roles are pared back, hollowed out, or outsourced entirely.

Historical Perspective on Globalization and Purchasing Power

A historical review of globalization reveals its significant impact on increasing net purchasing power. Over the past several decades, globalization has driven economic growth, expanded markets, and enhanced consumer choice. The post-World War II era saw a marked increase in global trade and economic integration, leading to unprecedented economic expansion.

Trade liberalization and the reduction of tariffs facilitated access to a wider array of goods and services at lower prices. This benefitted consumers, particularly in the West. Technological advancements, spurred by global competition, further contributed to productivity gains and economic efficiency.

Furthermore, globalization’s economic benefits were not limited to developed countries. Emerging economies, particularly in Asia, leveraged globalization to achieve rapid industrialization and poverty reduction. Countries like China and India lifted millions out of poverty faster than at any time in human history.

Alongside this increase in living standards in the developing world, the West is currently grappling with demographic challenges. These include aging populations and declining birth rates. As the working-age population shrinks, the burden on social security systems increases, and labor shortages become more pronounced. Immigration could be a critical solution to these challenges, with immigrants playing a vital role in replenishing the labor force, driving innovation, and supporting economic growth.

The temptation at a time of rising intra-country income equality is to curtail immigration severely. Australia, Canada, and the United Kingdom have already done so. However, abandoning globalization and immigration in response to short-term economic challenges is not without consequences. Immigration addresses demographic imbalances and supports economic growth in sectors from quantum computing to housing construction.

Effective management of globalization and immigration involves implementing policies that maximize their benefits while addressing potential downsides. This is easy to state and fiendishly hard to do. The current trend appears firmly in the realm of ‘pull the migration lever’ to curtail income inequality. Over the medium term, the opposite effect may occur.

Addressing Income Inequality – A Focus on Capitalism

It is becoming increasingly evident that rising income inequality inside nations poses moral, economic, and political challenges. The rise of populists, the instability of voting patterns, historical electoral voting patterns, and demographic coalitions are clear evidence of this in the political sphere.

From a moral perspective, stark disparities in wealth and income undermine social cohesion and the principles of fairness and justice. Extreme inequality can erode trust in institutions and foster social unrest, as individuals perceive the system as rigged in favor of a privileged few.

Meanwhile, from an economically rationalist perspective, high levels of inequality are inefficient. When wealth is concentrated in the hands of a few, it limits the overall circulation of capital within the economy. This concentration can stifle consumer demand. The lower and middle classes are likelier to spend more of their income. Income inequality coupled with inflation means this demographic segment struggles to make ends meet, curtailing their spending.

Addressing income inequality requires a critical examination and reform of contemporary capitalism. One potential reform is to shift the focus from short-term profit maximization to long-term value creation. This involves encouraging businesses to invest in their workforce, embrace sustainable practices, and prioritize stakeholder interests alongside or even above the value delivered to shareholders.

Another reform is enhancing corporate governance to ensure executive compensation is aligned with broader economic and social goals. Implementing policies that promote transparency and accountability in corporate practices can help mitigate the excessive concentration of wealth among top executives.

Effective policy measures are crucial to mitigating income inequality while embracing the benefits of globalization.

• Progressive taxation is a vital tool in this regard.
• Investing in education and vocational training is another. Equipping individuals with the skills needed to thrive in a globalized economy can enhance social mobility and reduce income disparities.
• Social safety nets are essential in mitigating the adverse effects of income inequality.
• Finally, fostering inclusive economic growth by supporting small and medium-sized enterprises can create more job opportunities, provide employment and upskilling opportunities, and drive local economic development. The long-term economic success of the German Mittelstand model is a testament to this.

Key Takeaways

This piece has touched on the intricate web of relationships between globalization, income inequality, and the functioning of contemporary capitalism. We began by examining how globalization impacts income inequality both within and between countries, highlighting the correlation often drawn between globalization and economic woes. We then delved into the role of populist rhetoric in scapegoating globalization and immigration, followed by a historical perspective that underscores the net benefits of globalization on purchasing power and the necessity of immigration in addressing demographic challenges.

We also emphasized the broader issue of contemporary capitalism’s role in exacerbating income inequality. Through the lens of the ‘profit trap,’ we explored how current capitalist practices can lead to economic disparities and discussed potential reforms to foster more equitable income distribution. Finally, we suggested various practical policy measures aimed at mitigating income inequality while embracing the benefits of globalization.

As with all the complex things we turn our minds to, the path forward requires a nuanced understanding of the complex interplay between globalization and capitalism and a clear-eyed diagnosis of its limitations.

By addressing capitalism’s structural inefficiencies, we can perhaps collectively address income inequality and defend the benefits that an interconnected, vibrant global marketplace delivers for each of us and our families.