Unit 4: Comparative advantage & Income inequality

The poor countries should catch up with the richer ones, in theory, at least. And between 1988 and 2008, global inequality, as measured by the distribution of income between rich and poor countries, has narrowed, according to the World Bank. But within each country, there has been widening inequality in many poor places.

According to The Economist this can be seen in the Gini index, a measure of inequality. (If the index is one, a country’s entire income goes to one person; if zero, the spoils are equally divided.) Sub-Saharan Africa saw its Gini index rise by 9% between 1993 and 2008. China’s soared by 34% over 20 years. It has hardly fallen anywhere.

The article explains why this is a puzzle, given economists’ confidence in the concept of comparative advantage. Economies export what they are relatively efficient at producing. Take America and Bangladesh now. In America the ratio of highly skilled to low-skilled workers is high. In Bangladesh it is low. So America focuses on products requiring highly skilled labour, such as financial services and software. Bangladesh focuses on simpler products such as garments. Comparative advantage predicts that when a poor country starts to trade globally, demand for low-skilled workers will rise disproportionately. That, in turn, should boost their wages relative to those of higher-skilled locals, and so push down income inequality within that country.

Economists have wondered why this hasn’t been happening.

A (simplified) account of their findings is that the latest wave of globalisation has jumbled workforces: high-skilled workers in poor countries can now work more easily with low-skilled workers in rich ones, leaving their poor neighbours in the lurch. Take “intermediate goods”, the semi-finished products that account for about two-thirds of world trade. The production processes outsourced by big companies in factories or call-centres are by rich-world standards unskilled. But when jobs are sent offshore, they are snapped up by relatively skilled ones in poor countries. According to research, the typical call-centre employee in India has a university degree.

In the modern, interconnected world, such workers come into more regular contact with less-skilled people in the rich world. The result of booming trade in intermediate goods is higher demand and productivity for skilled poor-country workers. Higher wages ensue: multinationals in developing countries pay manufacturing wages above the norm for the country. One study showed that in Mexico export-oriented firms pay wages 60% higher than non-exporting ones. Another found that foreign-owned plants in Indonesia paid white-collar workers 70% more than locally owned firms. Globalisation, though, does not boost wages for all. The least skilled cannot “match” with skilled workers in rich countries; worse, they have lost access to skilled workers in their own economies. 

The result is growing income inequality.