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The Impact of Globalization on the World’s Poor

by Machiko Nissanke and Erik Thorbecke

The process of globalization provides a golden opportunity for mankind to contribute to a major reduction of poverty world-wide. While the potential for povertyreduction is great, the extent of it will depend on many factors including, in particular, the pattern of growth followed by the developed and developing countries and the overall global policy framework. A question that is often raised is whether the actual distribution of gains is fair and whether the poor benefit less than proportionately from globalization—and could under some circumstances actually be hurt by it. The risks and costs brought about by globalization can be significant for fragile developing economies and the world’s poor. The downside of globalization is most vividly epitomized at times of periodical global financial and economic crises. The costs of the repeated crises associated with economic and financial globalization appear to have been borne overwhelmingly by the developing world, and often disproportionately so by the poor who are the most vulnerable. On the other hand, benefits from globalization in booming times are not necessarily shared widely and equally in the global community.

The fear that the poor have in some instances been by-passed or actually hurt by globalization was highlighted by recent studies which point towards limited—if not a lack of—convergence among participating national economies and across regions as globalization has proceeded. The observed trend towards greater inequality in the world income distribution between countries and regions (when the latter are not weighed by population size) and within many developing countries has a close bearing on conditions affecting the world’s poor, as inequality acts as a filter between growth and poverty. In particular, inequality may affect growth and thereby poverty alleviation in the future.

The most recent estimate suggests the share of the population of the developing countries living below US$1 per day declined from 40% in 1981 to 21% in 2001. However, this progress on poverty reduction was mainly achieved by the substantial reduction of the poor in China (400 million fewer people were poor in China in 2001, compared to the estimate in 1981). Further, it is reported that the absolute number of the poor has fallen only in Asia and risen elsewhere and the total number of people living under US$2 per day actually increased worldwide. In particular, poverty has increased significantly in Africa in terms of poverty incidence as well as depth of poverty.

Though any trend in poverty and income inequality observed so far cannot be exclusively or even mainly attributed to the ‘globalization’ effect, as such, without rigorous analyses, these various estimates, even the most optimistic ones, can not dismiss the concerns raised that the globalization process may have had at least some adverse effects on poverty and income distribution. These concerns have generated a passionate debate worldwide as well as a powerful anti-globalization movement.

The globalization-poverty relationship is complex and heterogeneous, involving multifaceted channels. It is highly probable that globalization-poverty relationships may be non-linear in many aspects, involving several threshold effects. It may be futile to attempt to establish theoretically, on an a priori basis, the effects of globalization on poverty as universally observable conditions. Indeed, each sub-set of links embedded in the globalization (openness)-growth-income distribution-poverty nexus can be contentious and controversial. Besides the ‘growth’ effects of globalization on poverty (i.e. the effects of globalization on poverty filtered directly through economic growth), the globalization/ integration process operating through various other channels is known to create winners and losers, affecting both vertical and horizontal inequalities. These channels include changes in relative factor and good prices, factor movements, the nature of technological change and diffusion, the impact of globalization on volatility and vulnerability, the world-wide flow of information, and global disinflation.

CHANNELS AND LINKAGES

The Growth Channel through which Globalization Affects the Poor

Policies of openness through liberalisation of trade and investment regimes and capital movements have been advocated worldwide for their growth-enhancing effects. However, the direction of causality between openness and growth is still debated and the positive openness-growth link is neither spontaneously achieved nor universally observable.

Moreover, there are two contradictory theoretical strands relating income—and wealth inequality to growth, which11 constitutes the second link in the causal chain from openness to poverty through the ‘growth’ effect. The conventional view is to emphasise the growth-enhancing effect of inequality through higher aggregate savings and capital accumulation as well as on the basis of existence of investment indivisibilities and incentive effects. The contrasting new political economy literature links greater inequality to reduced growth operating through a number of sub-channels, such as: unproductive rent-seeking activities that reduce the security of property; the diffusion of political and social instability leading to greater uncertainty and lower investment; redistributive policies encouraged by income inequality that impose disincentives on the rich to invest and accumulate resources; imperfect credit markets resulting in underinvestment by the poor— particularly in human capital, and the lower fertility rates that are associated with a larger share of total income accruing to the middle class (see Figure 1).

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The proponents of this new political economy approach argue that growth patterns yielding more inequality in the income distribution would, in turn, engender lower future growth paths. This would then also affect the potential for poverty alleviation. Thus, according to this school of thought successful poverty alleviation depends not only on favourable changes in average GDP per capita growth but also on favourable changes in income inequality. Inequality is an impediment to poverty-reducing growth, as the elasticity of poverty with respect to growth is found to decline with the extent of inequality. As the pattern of economic growth and development, rather than the rate of growth per se, would have significant effects on a country’s future income distribution and poverty profile, a search for pro-poor growth or distribution—neutral growth is essential.

Indeed, in a world of interdependent evolution, openness is a necessary but not a sufficient condition for successful development. All countries have to undergo a structural transformation throughout the process of development. The key issue in starting the cumulative growth process at an early phase of development is how to generate the resources required to reach the take-off point. At the outset of the development process a country is predominantly agrarian and the economy is relatively closed.

A continuing gross flow of resources should be provided to agriculture in the form of such elements as irrigation, inputs, research and credit, combined with appropriate institutions and price policies to increase this sector’s productivity and potential capacity of contributing an even larger flow to the rest of the economy and hence a net surplus later on to finance the incipient industrialisation process. The experience of East Asia has demonstrated that after reaching the take-off point, a careful structural transformation generates a growth process that is pro-poor, whilst taking advantage of the potential benefits of openness.

Other Channels through which Globalization Affects Inequality and Poverty

The income distribution effects induced by a shift in relative product prices in the process of opening up of trade are well known as postulated in the SamuelsonStolper theorem of international trade theory. The losers (especially, the poor residing in either urban or rural area) may be vulnerable to these induced effects in addition to changes in absolute and relative prices of wage goods. While developing countries, well endowed with unskilled labour should experience a decline in income inequality through an increased demand for unskilled labour, the postulated narrowing wage gaps between skilled and unskilled labour have not been observed in many developing countries, particularly in Latin America and Africa. This could be explained by many factors, including: i) the nature of new technology heavily biased in favour of skilled and educated labour; and ii) the entry into the world markets of lowincome Asian economies with abundant reserves of unskilled labour such as China and India.

The highly differentiated degree of cross-border factor (labour and capital) mobility observed today may be identified as another channel of producing winners and losers as a result of globalization. In particular, the extent of cross-border mobility differs significantly between skilled and unskilled labour. In consequence, the ‘wage equalization’ process is less likely to take place through labour migration. More generally, there are some distinctive features of factor movements: i) capital and skilled labour do not migrate to poor countries as much as among developed countries; ii) there is a tendency for skilled labour to migrate from developing countries to developed countries; and iii) with capital market liberalization, there is a propensity for capital flight to developed countries, particularly during periods of crisis or instability. With such ‘perverse’ movements, as globalization proceeds, developed countries would see inequality fall, while developing countries would experience rising inequality.

While the mobility of unskilled labour is severely restricted and regulated, de facto labour mobility has taken place through the increasingly free cross-border capital mobility and the ability of Multi-National Corporations (MNCs) to re-locate production sites in response to changes in relative labour costs. In fear of driving away MNCs, governments of developing countries are less likely to enact regulations to protect and enhance labour rights. Thus, the differential factor mobility as observed over the recent decades may profoundly affect the functional income distribution between labour and capital.

The process of globalization provides a golden opportunity for mankind to contribute to a major reduction of poverty world-wide. © Lehtikuva / AP Photo / Bob Edme
The process of globalization provides a golden opportunity for mankind to contribute to a major reduction of poverty world-wide. © Lehtikuva / AP Photo / Bob Edme

The nature of technical progress and of the technological diffusion process can be a further channel through which globalisation could affect income distribution and poverty. Technical change emanates predominantly from R&D activities in the developed countries in response to conditions typical of their own resource endowment. Hence, technical change tends to be labour-saving, capital-intensive and skill-biased, and would tend to increase inequalities in both developed and developing countries by creating a wider wage-gap. There is a high degree of substitutability between unskilled labour and capital, in contrast to the high degree of complementarity between skilled labour and capital. Furthermore, technological diffusion and access to new technology is not universal and spontaneous. Hence, productivity differences may widen globally over time, which may increase income inequality. In particular, globalization has accelerated the process of privatization, including the privatization of research, which could make it harder and, in some instances, costlier for developing countries to access the new technology. A possible case in point might be in the domain of agricultural technology where the new bio-technological revolution is developed by large private corporations in contrast with the earlier Green Revolution which was in the public domain.​

Greater openness also tends to be associated with greater volatility and economic shocks, which affect the vulnerable and the poor households harder and deepens poverty and income inequality at least temporarily. There is some evidence that the poor are hurt proportionately more during contractionary periods than they benefit from expansionary periods. For example, the Asian Financial Crisis hit hardest the poor households in the urban areas — lacking safety nets.

The poor are often not well positioned to take advantage of new opportunities opened up by the enormous increase in the flow of information world-wide. Finally, while global disinflation brought benefits in terms of macroeconomic and monetary stability, the latter may have been achieved, in some instances, at the expense of some additional growth. The common condition of fiscal retrenchment observed worldwide may have contributed to the erosion of governments’ capacity to raise revenues for re-distributional purposes.

POLICY IMPLICATIONS

The observed ‘between-country’ income divergence trend tends to bring into question the validity of the income convergence thesis. Indeed, a mere adoption of open trade and investment regimes does not guarantee developing countries’ entry into the convergence club. Many poor countries, which have opened their economies since 1980s, have fallen behind not just relatively but absolutely in terms of both income levels and structural development. Whether global market forces establish a virtuous circle or vicious circle will depend on the initial conditions at the time of exposure and the effective design and implementation of policies at the national and international level to manage the integration process.

A strategic position towards globalisation cannot be equated with a simple fine-tuning of the pace and sequence of liberalization measures. Clearly, it is a question concerning the pattern or forms of integration. In particular, national development policies should be strategically designed in the light of the potentially skewed nature of the on-going process of globalization discussed above.

Given the observed trends towards greater inequality in per capita income levels between countries and within many countries, developing countries have to take strategic steps to protect themselves in order to derive benefits from the dynamic forces of globalization, with a long-term vision for upgrading their comparative advantages towards high-value added activities. Governments of developing countries to succeed in this endeavour should consciously engage in building institutional capacities for integration, including a capable nation-state that is ready to take on the enormous challenges posed by globalization.

This calls for effective complementary policies and safety nets to be in place at both national and global levels. Policymakers need to design and implement an active development strategy not only to benefit from, but also to help counteract the negative effects of the immutable forces of globalization. It is not enough for governments to assume an active role in liberalizing trade and capital movements and de-regulating their economies, while passively waiting for the fruits of the ‘Washington consensus’ and the market forces of globalization to pull them on a fast development track. Instead, governments need to pursue both active liberalization and active domestic development policies. Those who argue that we need more equitable forms and processes of globalization to start with need to confront the fact that any contemplated changes in the nature of the present forces of globalization require a much better grasp of the concept of ‘pro-poor globalization’ than we presently hold. It is only through rigorous and well focussed studies that many of the questions raised above relative to the impact of globalization on poverty can be apprehended and, hopefully, answered within a specific context.

Machiko Nissanke is Professor of Economics at the School of Oriental and Asian Studies (SOAS), University of London.

Erik Thorbecke is Graduate School Professor and Professor of Economics Emeritus at Cornell University.

Machiko Nissanke and Erik Thorbecke are the co-directors of the UNU-WIDER project on ‘The Impact of Globalization on the World’s Poor’.

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