Globalisation Has Failed to Reduce Inequality

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Contrary to established theory, globalisation has increased, rather than reduced, inequality in emerging economies. To solve this problem, more opportunities should be created enabling people to acquire new skills. Nobel Prize laureate and Professor at Harvard, Eric S. Maskin, who is also Chief Research Fellow at the International Centre of Decision Choice and Analysis of the HSE Faculty of Economic Sciences and Honorary Professor at HSE University, shared his insights on the topic.

In a lecture titled 'Why Globalization Has Failed to Reduce Inequality,' Professor Maskin argues that the internalisation of production is the main factor. The event was moderated by Fuad T. Aleskerov, Director of the International Centre of Decision Choice and Analysis and Professor at the HSE Faculty of Economic Sciences.

In recent decades, international trade has grown dramatically, facilitated by the development of infrastructure and decrease in transportation and communication costs. Globalisation was expected to bring prosperity to all countries involved in trade and to reduce inequality. While hundreds of millions of people have indeed been lifted out of extreme poverty by the development of China and other countries, inequality in emerging economies has, in fact, increased. Although the news media today often highlight the growth of inequality in rich countries and the stagnation of middle-class incomes, Professor Maskin suggests focusing specifically on emerging economies, with their huge income gaps between the rich and the poor, and emphasises the importance of addressing inequality in the global economy to maintain social and political stability.

Eric S. Maskin

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According to Professor Maskin, the surprising increase in inequality in poor countries clearly contradicts the theory of comparative advantage proposed by economist David Ricardo in the 19th century. This theory states that countries should specialise in producing goods they can produce at a lower cost than their neighbours. Then, everyone will benefit from trading, leading to higher incomes and reduced inequality. Professor Maskin uses the example of two countries: one rich and the other poor. A rich country, with a higher proportion of highly skilled workers, enjoys an advantage in producing software but is less efficient in producing rice compared to a poorer country with a higher proportion of low-skilled workers. These two countries benefit from trading with each other: the rich country sells software to the poor one, while the latter sells rice to the former. This will result in increased demand for low-skilled workers in the poor country and, in turn, will lead to higher wages of rice producers, increased incomes in the poor country, and reduced inequality.

History in the second half of the nineteenth century unfolded in complete accordance with this theory. Europe had a relative abundance of low-skill labour, whereas the United States was better endowed with high-skill labour. Trade between the United States and Europe increased, and inequality fell substantially in Europe—although it increased in the US. However, this theory does not hold true in the current era of globalisation, as inequality in emerging economies has been growing.

Eric S. Maskin, in collaboration with Michael Kremer, have developed an alternative model that helps fill in the gaps that classical theory cannot explain. They posit that the distinction lies in the internationalisation of the production process. Today, manufacturing a product involves multiple countries: computers are often designed in the United States, programmed in Europe, and assembled in China. Each element of this chain requires a different skill level. While the classical model assumed just two levels—unskilled and highly skilled workers—in both poor and rich countries, today, a greater variety of skill levels is required to capture a global labour market. To illustrate the model, Maskin supposes there are four levels of worker skills in two countries: one rich and one poor.

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He further assumes that the rich country has workers of skill levels A and B, and the poor country has workers of skill levels C and D, where A is the highest, and D is the lowest level. The workers’ tasks in the production process are arranged in a way that makes their positions hardly interchangeable. For example, workers from poor countries will most likely not be able to take on managerial positions in a global corporation due to a lack of relevant experience. Production output depends on how workers of different skill levels are 'matched' together. In past eras of globalisation, A-workers matched with B-workers in the rich county, and C-workers matched with D-workers in the poor country. This led to an increase in the wages of the least skilled workers, improved societal wealth, and reduced inequality. But that is not the case today. The division of labour and internationalisation have resulted in a matching pattern where lower skilled D-workers are matched and compete only with low-skilled C-workers. D-workers are denied the opportunity to increase their productivity or acquire new skills, and their incomes become stagnant. In contrast, more experienced C-workers benefit from globalisation thanks to the new opportunity to be matched with B-workers in the rich country. This amplifies the gap between C- and D-workers, thus increasing inequality in the poor country. Empirical studies confirm this: the Gini coefficient in China has grown dramatically over the past few decades.

However, according to Professor Maskin, combating globalisation is not the solution. He argues instead for investing in job training programmes to enable disadvantaged workers to acquire new skills. But who is going to pay for it? According to Maskin, the workers cannot carry the cost themselves, while their employers may not have the incentive to pay for the training, because a more productive worker will command a higher wage. This leaves a significant role for a third party, such as the government, which is interested in developing human capital and boosting productivity. Professor Maskin is confident that policymakers are in a position to ensure that all workers have the opportunity to acquire new skills and also benefit from globalisation.