Inequality Is Declining in Developing Nations and Will Decline in the West, Too

Commentators in the West often write as if increasing economic inequality were a world-wide phenomenon. The implication is that globalization, or economic “neo-liberalism,” uniformly creates an increasing gulf between the haves and have-nots everywhere in the world. In fact, however, inequality has not been getting generally worse in the developing world. In a good number of developing nations, inequality has been declining, and for the same reason it’s been increasing in the West. This development, however, throws a wrench into the narrative that globalization uniformly increases economic inequality. It also suggests increasingly inequality will taper off on its own accord in the West.

Among other characteristics, globalization reflects decreasing costs to the mobility of economic inputs and outputs. Globalization means it is generally cheaper for labor and capital to cross national borders. It means it is cheaper for finished products to cross national borders. Uniformly declining costs, however, have different effects in different nations, depending on their relative ratios of capital to labor. This is a cross-national implication of the Stolper-Samuelson theorem.

What the theorem suggests is this: declining costs will increase returns to relatively abundant factors of production and will decrease returns to relatively scarce factors of production. What factors are relatively abundant and which factors are relatively scarce, however, differ across different countries. For example, in the United States, and in the West more generally, capital is abundant relative to labor. In most lesser-developed nations, labor is abundant relative to capital. As the cost of moving factors of production across national borders declines, and so the cost of production itself, then the theorem predicts different outcomes in different countries, depending on nation’s relative mix of labor and capital.

In the West, where capital is abundant relative to labor, the theorem predicts increasing returns to capital holders, and decreasing returns to labor. Given that wealthy households tend to own more capital than poorer households, this implies what we see in the West, that the rich get richer. (Keep in mind this is relative affluence. That the “poor get poorer” means only relative to the rich, it does not necessarily entail that less affluent households in the West have less to eat or to spend in absolute terms.)

In developing nations, however, where labor is abundant relative to capital, the theorem predicts the opposite of the West’s experience. It predicts increasing returns to labor and decreasing returns to capital. Given, again, that wealthy households tend to hold more capital than poorer households, this suggests declining economic inequality in lesser-developed nations. The poor would be getting richer and the richer would be getting poorer, relative to each other.

To be sure, the decline in absolute numbers of extreme poverty throughout the world – one billion souls escaping extreme poverty in recent decades – is certainly pertinent evidence. Nonetheless, it is possible in these countries that, even with astonishing decreases in absolute poverty, relative inequality has nonetheless increased.

Economists Nathalie Chusseau and Joël Hellier, in a working paper on “Inequality in Emerging Countries,” report “diverse” trends in inequality within lesser developed nations. This may seem to be a weak result. It is much more significant than it first appears.

Recall first that the economic inequality has been increasing throughout the developed nations in recent decades. This is not the experience in less developed nations. Chusseau and Hellier report “Emerging East Asian countries experienced a decrease in inequality during the seventies and eighties” with unclear trends in recent decades. So, too, “After a continuous increase in inequality in the 1990s, a majority of Latin American countries have experienced a decrease in inequality in the 2000s.” They suggest the overall evidence implies “a turning point towards more equality could have occurred in the 2000s for a number of [emerging] countries.” I don’t want to style the evidence as more consistent than they present it: inequality in fact increased in many lesser developed nations at different times during this period. The point, however, is this trend has not been consistent as it has among developed nations. And, indeed, during these same decades, in numerous developing countries, economic inequality in fact declined.

More compelling news comes in Chusseau and Hellier’s unpacking of what caused the declining inequality in countries in which it has declined and what caused the increasing inequality in those countries in which it increased. They write:

The Stolper-Samuelson effect lowers inequality, as well as growth-related pro-education policies. On the other hand, technological transfers, the cornering of new skill intensive industries, the increase in the size of the South and technological catching up tend to increase inequality.

First we should note their conclusion that the “Stolper-Samuelson effect lowers inequality” (as well as increased education). Secondly, however, they observe it is technology transfers (also a result of globalization) that has increased inequality by increasing income going to skilled workers.

It is important to note increasing inequality caused by technologically skilled labor is not inequality increasing due to increase returns to capital. It is not the one-percent getting richer. This inequality results from the development of a middle class. We don’t want to “solve” this cause of inequality, we want more workers to take advantage of technologically-inspired income gains.

There are a couple of lessons for the West. First, the Western experience with increasing economic inequality cannot be generalized worldwide. Secondly, there is a connection between increasing returns to capital in the West and increasing wages in lesser-developed nations. This means there is a connection between increasing inequality in the West and decreasing inequality due to the Stolper-Samuelson effect in lesser-developed nations. Finally, the process generating increased inequality in the West will not continue indefinitely. As relative ratios of capital to labor equilibrate over time, outsized returns to capital in the West, and outsized returns to labor in developing countries, will disappear. Economic inequality in the West will stop increasing, and labor income will once again increase at the same rate as the return on capital. Increasing inequality in the West is a huge, one-off occurrence.