The Effects of Globalization on Inequality: a Cross-national Analysis

Why does globalization produce income inequality? Over the last twenty years we have seen a steep rise in income inequality worldwide that reversed a prior equalizing trend. The rise in inequality appears closely linked to the rapid increase in the integration of world trade and in international investment that we call economic globalization. We examine the relationship between foreign investment dependence and income inequality, and compare it to theories that focus on world trade. The evidence provides strong support for the theory that nations highly dependent on foreign capital experience high and worsening income inequality. Exploitation also increases inequality while democracy and education reduce it. Other sources of inequality derived from modernization theory or dual sector models do not remain significant in our models. Considering the dramatic increase in foreign investment in recent years, the implications of this finding for poverty reduction and political stability are stark. Introduction The contemporary era is one of both accelerated economic globalization and rising inequality. International markets for goods, services, and capital have become increasingly integrated and, since the 1980s, this trend has shown a sharply upward curve (Rodrick 1997; Brady and Wallace 2000). Economic inequality has increased during this time period as well, whether measured between individuals, between nations, or within nations (Berry et al 1991; Ram 1992; Korezeniwicz and Moran 1997). Milanovic (1999) estimates that the world Gini index for the richest to the poorest income groups increased one percent per year between 1988 and 1993, (from .63 to .66.), while the World Development Report finds that GDP per capita in the richest 20 countries has grown to 37 times that of the poorest 20 nations, a gap that has doubled in the past 40 years (2000/01). There is an increasing awareness among both academic scholars and development professionals that globalization puts certain populations at risk (Rodrick 1997; Birdsall 1999, UNCTAD 2000). This contrasts with a “Washington consensus” among global elites that emphasized trade and investment liberalization as the panacea to development problems in the 1980s and early 1990s. The key turning point was the impoverishment left behind by the East Asian currency crisis of 1997 and subsequent meltdowns from Russia to Brazil, which produced earnest calls, often by the same elites, to take heed of the ways in which globalization has had unequal effects among the world’s population, both within and between nations. Since the agenda-setting success of the “Battle of Seattle,” ‘globalization’ has become the unifier of diverse grass-root social movements in a string of large scale protests when the WTO, IMF, or other global policy makers try to meet. Inequality is back on the global agenda, according to the World Bank’s World Development Report (2000/01). However, there has been inadequate theoretical analysis and up to date empirical studies that explain just how contemporary globalization affects inequality and the well-being of individuals (Paus and Robinson 1997). To examine the effects of globalization on inequality, we start with world-system theory, which emphasizes the developmental consequences of global relations between unequally powerful nations, in particular, relations of dependency. Since the 1970s, much of this work is concerned with the effects of accumulated investment from transnational corporations (TNCs) in the developing world, or periphery. Specifically, studies of ‘capital dependency’ or TNC ‘penetration’ contend that disproportionate control over host economies by transnational corporations increases inequality by altering the development patterns of these nations. Although the vast majority of foreign direct investment (FDI) is located within developed nations, the impact of FDI on a developing nations economy is much more significant (WIR 2000). Therefore, world-system scholars focus on dependency in the form of accumulated stocks of foreign investment as a share of the host nations GDP. Our focus on dependency is in sharp contrast with most globalization studies. While globalization has multiple economic, political, and cultural facets, when studying 1 See, for instance, Chase-Dunn 1975; Bornschier 1981; Rubinson 1976; Bornschier and Ballmer-Cao 1979; Dolan and Tomlin 1980; Evans and Timberlake 1980; Sullivan 1983; Bornschier and Chase-Dunn 1985;Dixon and Boswell 1996; Beer 1999. inequality most have focused on the effects of international trade, neglecting the significance of foreign ownership (Rodrick 1997; Ferreira and Litchfield 1998; Lachler 1998; WDR 2000/01). Similarly, with some important exceptions (i.e. Tsai 1995; Dixon and Boswell 1996; Alderson and Nielsen 1999), most recent cross-national studies of income inequality have moved away from examining global forces like foreign direct investment (FDI), focusing instead, on economic and socio-cultural dualism (Williamson 1991; Nielsen and Alderson 1995) or technoecological heritage (Lenski and Nolan 1985; Crenshaw and Ameen 1994). This is surprising for two reasons. First, dependency arguments concerning the impact of FDI on inequality have received relatively robust empirical support, warranting further examination. Second, foreign direct investment has dramatically increased in importance over the past two decades, and is currently the primary source of resource flows to developing nations (Froot 1993; Tsai 1995). In 1988, FDI surpassed all other forms of lending as a source of foreign capital to developing nations (WDR 1991). In 1982, the total value of global inward FDI stock stood at almost 6 billion (US$), by 1990 that figure had reached 1.7 trillion (US$), and by 1999 it had reached 4.7 trillion (WIR2000). The ratio of world FDI stock to world GDP increased from 5% in 1980 to 16% in 2000 (WIR 2000). Indeed, less developed countries are encouraged to attract foreign investment as the primary route to economic growth and well-being in the contemporary world-economy. Foreign investment is promoted by development agencies such as the World Bank and the International Monetary Fund as an efficient way to add to existing domestic pools of capital, technology and entrepreneurial 2 Some seem to conclude that the insignificance of core/periphery dummy variables invalidates any worldtalent (McMichael 1996; Rothgeb 1996; WIR 1991). Implicit in the logic of investment liberalization is the idea that the free flow of unregulated capital is the best means to national development (Ranney 1998). It is only recently that traditional development agencies have begun to realize that FDI may disadvantage certain groups of individuals and that it is incumbent upon policymakers to safeguard vulnerable populations (UNCTAD 2000). This study attempts to specify the conditions under which transnational corporate (TNC) penetration and other global factors influence changes in domestic income distribution in the hopes that this knowledge may allow us to develop more effective policies to mitigate these inequalities. Due to a prior lack of high quality time-series income inequality data, most cross-national studies of income distribution have employed regression models with a cross-sectional design. It is clear that the lack of time-series and longitudinal analyses covering many countries is a significant gap in the literature concerning cross-national income inequality. Moreover, examining changes in inequality over time has theoretical and empirical benefits. It enables an analysis of the impact of contemporary globalization on inequality and an evaluation of the sometimes contradictory findings of prior research. This paper presents an analysis of the determinants of change in national income distribution using linear regression models with a panel design. The data set contains inequality data for 65 nations at two points in time, circa 1980 and 1995. Our central concern is the effects of economic globalization on national income distribution, with an emphasis on transnational corporate penetration. system approach, even though such dummies are the crudest possible measures (i.e. Muller 1988). Theoretical Perspectives on Cross-National Income Inequality There are three main world-system arguments concerning the global sources of domestic income inequality, which follow a rough temporal pattern. The first focuses on inequalities arising from the concentration of land ownership that generates severe income inequality. Land concentration begins as a legacy of colonialism and continues through corporate agriculture (Furtado 1970; Muller and Seligson 1987; Boswell and Dixon 1990). Many cross-national studies have found a positive association between land inequality and inequitable distribution of income (Simpson 1993; Crenshaw 1993; Crenshaw and Ameen 1994). In the examination of the relationship between growth and inequality, some researchers have found that land redistribution prior to the onset of economic expansion is a crucial intervening variable (Bowman 1997; Deininger and Squire 1997). The second argument emphasizes the export structure of developing nations. Trade between industrial and industrializing countries creates dependent patterns of unequal exchange, leading to high levels of income inequality within the developing world (Baran 1957; Frank 1967; Galtung 1971). Export-oriented production for the world market creates sector dualism in which the primarily foreign-owned export segment of the developing economy monopolizes internal capital and repatriates profits, stagnating the domestic sector. The empirical evidence indicates that large export sectors are positively related to income inequality (Stack 1980; Prechel 1985). The more capital intensive nature of export production results in higher returns to capitalists at one end and the underemployment of the indigenous labor force at the other. Moreover, wages are depressed by limited labor force mobility between sectors, due to lack of skill transferability, low education levels, and various social and legal barriers (Amin 1976; Prechel 1985). Prechel (1985) argues that the productive capacities and structure of the export and traditional economic sectors of developing nations are linked and not simply temporarily disarticulated. The growth of the first depends on the stagnation of the latter. Furthermore, creation of a high-wage high-profit oligopolistic capitalist sector not only creates a minority of high-income employees, it further increases inequality by encouraging urban migration and increased competition for unskilled jobs (Evans and Timberlake 1980). Competition in crowded urban areas reduces wages by decreasing the bargaining power of labor. These tendencies are exacerbated by the development strategies most developing nations pursue. Prechel discusses the implications of these strategies for increasing income inequality, arguing that export-oriented production is usually foreign-owned or financed. This leaves these economies vulnerable to fluctuations in the world market, which along with the factors already discussed, contributes to maintenance of high levels of income inequality. The subordinate position of peripheral governments vis-a-vis core capital and prominent transnational actors such as the IMF, decrease their ability to implement autonomous social and economic policies