Wondering Why Trump Loves Tariffs? Check Out Globalization’s Inequality Impact

By Karen Shaw Petrou

When the IMF was established at Bretton Woods in 1945, it was key to the post-war creation of a globalized international economic and financial system.  That was then.  Now, the Fund has released a ground-breaking paper finding that globalization not only does not boost growth in advanced economies, but also appears to worsen income inequality.  The paper does not go on to push for protectionism – blasphemy at the Fund and not borne out for trade in goods by the detailed findings of this study.  It does, though, show that the more globalized capital flows grow in concert with more imports, the harder it is for low-skilled workers to get ahead.  No wonder the Rust Belt’s as angry as it said it was in 2016.

Globalization’s Cost

What is particularly refreshing about this paper is its openness to unintended consequences and its use not of theory, but of empirical data that captures non-linear and multi-dimensional effects at 147 countries over the 45 years after 1970.  Key findings are that:

• Globalization as diminishing marginal returns – that is, countries with the least globalization (e.g., China as a closed society) benefit the most from expanded inter-connectedness; conversely, the most globalized countries benefit the least.
• In already-globalized countries, more globalization does not lead to statistically-significant income improvement. Indeed, there is a “robustly positive and statistically significant effect of economic globalization on the Gini coefficient of net incomes [which rises as inequality grows].”
• This inequality effect is strongest in highly-globalized, advanced economies. Specifically, the paper finds that “A one point increase in the globalization score increases the top 10 percent’s income share by about 0.33 percentage points and the top 1 percent’s share by 0.24 percentage points.”
• These results assume that domestic policy-makers do nothing as globalization increases (i.e., no changes in fiscal policy, educational training, etc.). If policy counters the naturally dis-equalizing impact of globalization, then these adverse inequality results are not inevitable.

The study notes almost in passing that its findings would have been more optimistic about trade’s benefits to income equality had it stopped ten years ago.  Economic inequality is a cumulative process – that is, the more unequal an economy, the more unequal it becomes absent redistribution policy.  In the U.S., inequality was rising rapidly through 2004 to 2008 and, after a brief equalized moment at the worst of the crisis, then grew rapidly worse from both an income and wealth perspective.  Charts in my talk to the Federal Reserve Bank of New York show this in detail.  During this period, there were also no lasting redistribution fiscal policies – 2009 tax changes and infrastructure spending were quickly overtaken by fiscal stalemate, continuing recession, and the regressive effects of post-crisis monetary and regulatory policy.  With trade continuing unabated throughout this period, inequality had to get worse in response to ill-distributed income gains due in part to globalization.

All of these results explain Trump trade policy – that is, why lower-income households think “free trade” is pernicious – but it does not justify either new tariffs or the other protectionist measures favored not just by Trump, but also by advocates such as Bernie Sanders.  This is first because globalization does boost growth at least to some degree and inequality can be offset by progressive policy.  Secondly and even more interestingly, this study finds that it isn’t so much trade in goods that does the inequality damage; it’s free flowing capital because foreign direct investment largely benefits high-skilled workers.

Even more interestingly, the paper cites other research suggesting that large inflows of foreign direct investment also increase financial-crisis risk – a finding demonstrated not only by all too many emerging-market financial crises but also by the U.S. subprime debacle to the extent foreign investment in the sector fueled this blow-out.  Financial crises are, of course, not exactly beneficial to economic equality unless policy races to the rescue as proved the case in the 1930s and was so wanting in 2008.

Does the IMF Study Renounce Globalization?

How could it do so given the formidable institutional commitment to globalization?  Thus, the paper concludes by emphasizing the point noted above:  the inequality impact of globalization doesn’t have to be as bad if domestic policies mitigate the adverse equality effect.  Good luck, guys!