DeLong's Apology

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

The World's Income Distribution: Turning the Corner? by J. Bradford DeLong
is dated February 2001, a month before the official date of the currnet
recession in the US.  Still, his blind optimism can only be explained
that perhaps news of the collapsed of globalization since 1997 has yet
to reach his Berkley campus.

Delong claims that global income distribution has been trending towards equality. This claim flies in the face of World Bank data on the gini coefficient in both developed and devloping economies.

Although international markets for goods and capital have opened up since World War II and multilateral organizations now articulate rules and monitor the world economy, economic inequality among countries continues to increase. Some two billion people still earn less than $2 per day.  The number subsisting below the poverty line in India, nearly 400 million in 1992 (World Bank, 2000), is greater than India's total population was at the time when independence was proclaimed in 1949.   Despite spectaular growth in the past two decades, I have calculated that at current rates of growth, it would take China five centuries to catch up with the US in GDP. The gap between per capita GDP in the two economies is actually widening.

In the US, a Congressional Budget Office study shows that the average after-tax income of the richest one percent of Americans grew by $414,000 between 1979 and 1997, after adjusting for inflation, while average after-tax income fell $100 for the poorest 20 percent of Americans and grew a modest $3,400 for those exactly in the middle of the income spectrum.  In percentage terms, after-tax income grew an average of 157% over this period for the top one percent of the population, rose a modest 10% ? about one-half of one percent per year ? for the 20 percent of Americans in the middle of the income spectrum and was effectively unchanged for those in the bottom fifth. In America, the average real income of the poorest fifth fell by 3% during 1979-97.

Still, DeLong may be able to point to, with a facade of intellectual honesty, some statistical basis for his claim.  In some economies, such as China and India, the absolute income have risen nominally and sufficiently to yield comforting conclusion of increased equality on a global scale.  But this is accomplished by drastic domestic increases in income inequality.  Even in absolute terms, the case for improvement is not convincing.  True, some consumers in neo-liberal market economies tied to globalization have seen their nominal income rise.  But it is controversal to argue that the aggregate purchase power of these consumers has increased.  What has happened is that neo-liberal market systems force a trade off in consumption.  Workers the world over are forced to reduce their take of social services and benefits, such as healthy care, education, job security and pension, safety from crime and environmental pollution, in exchange for meager increases in income which they spend on electronic gadgets and designer fashion that they themselves produce at low wages, while the rich buy cars and high rise apartments, restaurants meals and vacation travel.  The symbols of prosperity in these emerging economy urban centers are not affordable by 99% of the population.  When it comes to health services, the increase in inequality worldwide is undeniable even to the casual observer.

Neo-liberalism asserts that inequality is the result of poverty, that as poverty is relieved, inequality recedes.  This assertion neglects the possibility that inequality itself causes poverty, not as calculations in a zero sum game, but as a damper on consumer demand in an overcapacity global economy.

Globalized trade has been hailed nu neo-liberals as the solution to inequality and poverty.  Opposition to globalization is described as misguided.  Last week,  as trade ministers from 142 countries met in Doha, the capital of Qatar for the latest round of the World Trade Organisation (WTO), the World Bank estimates that the trade barriers maintained by the developed world cost developing countries about $100 billion a year. That's twice the amount poor countries receive in aid. What makes it even worse is that it is goods such as textiles and garment and shoes that are hit hardest - the very industries that employ the poorest people in the poorest countries at the lowest wages. At the end of the 1990s, farm subsidies accounted for almost 40% of the value of OECD farm output, precisely the same as it was 10 years earlier. The total value of subsidies to farmers in the rich northern countries is a colossal $ 252 billion a year.  These two items alone add up to a direct annual transfer of $352 billion from the poor of the world to the rich.  For years the United Nations target for aid from rich countries to poor has stood at 0.7% of their GDP. Today it stands at 0.22%.

The Harrod-Domar model of economic growth had argued that unequal distribution of income should promote economic growth and greater employment because the rich save more than the poor;  a greater volume of domestic savings will increase the supply of resources available for investment; and accelerated capital formation will raise gross domestic product and resulting incomes, a virtuous cycle feeding back into greater savings. Thus, income inequality, even that reflecting widespread poverty, was regarded as good for development.   This is essentially the IMF model of market fundamentalism.  Notwithstanding that this model may not be operative in a world plagued by overcapacity from over-investment, the model neglects the fact that under globalized finance capitalism, the savings of the rich are siphoned off to US capital markets, draining the local economy of needed captial.  This increases the cost of capital for the poor economies which have to offer returns drastically higher to induce their own capital to return, putting these economies in a perpetual competitive disadvantage.

By the mid-1960s, the theory equating development with GNP growth were already not empirically supported by evidence.  But such evidence was systemically ignored by mainstream economics because it went against the prevailing paradigm, which seemed so intellectually logical and ideologically correct. Moreover, it went against established economic interests. If development was regarded as depending almost entirely upon capital as the scarcest, and thus as the most valuable factor of production, this justified the owners of capital receiving the largest share of the benefits from development.

About this time (1967), President Julius Nyerere of Tanzania presented in "The Arusha Declaration" a conceptual, not just empirical, challenge to the prevalent mainstream view. If poor countries have little capital and an abundance of labor, he asked, why not use whatever capital is available to make the most abundant resource, labor, more productive -- rather than use labor, often wastefully and certainly with poor remuneration, to make the resource they had least of, capital, particularly foreigners' capital, more productive?
Why should the poor seek to fight their war against poverty with the weapons of the rich? Nyerere asked pointedly.

This was dismissed as ideology rather a legitimate question by economists serving the interest of capital.  With the end of the Cold War, an unregulated global capital market was forced on the world, with free movement of capital to exploit globally the lowest labor cost and weakest environmental protection.  Globalization frees capital from national borders but not workers who are still restricted by national immigration laws. Mainstream economics never questions the dominant capital-favoring paradigm.  The case of the Asian tiger was held up as empirical proof, until 1997, when the mirage evaporated with the Asian financial crises.  The Asian tigers, as it turned out, were merely hunting dogs for global and mostly Western capital.

Skepticism about capital formation as the cause of economic growth is long overdue.
Classical economic theory views capital formation as a consequence of growth. It was neoclassical economics that puts capital formation as a prerequisite for growth.  This reversal distorted the neutrality of capital, projecting capitalism from an ideologically neutral economic process to the status of a religious dogma.  The market was elevated to the status of a sacred institution and market prices as an infallible equalizer of values, obeying the :natural" law of marginal utility.  Market prices reflect unequal distributions of income which distort the forces of demand and supply. The price system serves to maximize profits rather than to maximize human value or welfare. It also fails to reflect adequately the needs and interests of future generations who have yet to participate in the market.

Inequality is the cause of underdevelopment.  Inequality produces and perpetuates poverty. The most harmful inequality is that between capital and labor.  It is both immoral and dishonest to claim that inequality is receeding in the world when it is increasing everywhere.

Henry C.K. Liu

The World's Income Distribution: Turning the Corner?

J. Bradford DeLong
                           delong@xxxxxxxxxxxxxxxxx
               http://www.j-bradford-delong.net/

                                February 2001
 
 

    Twenty five years ago you could indeed powerfully argue that on a
    fundamental level the world economy was not working. It was
    generating better technology and more output, yes, but was it making
    good use of that output to advance social welfare? It seemed as
    though the answer was no, at least not for the poorer half of the
    people on the globe. As time passed the world was becoming richer,
    but it also became a massively more unequal place. The difference in
    living standards, productivity levels, and life chances between rich
    and poor parts of the world was greater in 1975 than it had been in
    1925, and vastly greater in 1975 than it had been in 1800.

    Since 1975, however, we have turned a very important corner. As Yale
    economist T. Paul Schultz was the first (to my knowledge) to point
    out, since 1975 global inequality in personal incomes has not been
    rising but falling. Since 1975 the world has not only become a
    richer place, but the world's poor have seen their incomes grow
    faster than the world's rich. From this perspective, therefore, the
    world economy has been performing a lot better in the last quarter
    century than in the previous two hundred years.

    Two hundred and fifty years ago the world economy was a relatively
    equal place. Everyone was very poor by our standards today--even by
    third world standards today. But the differences between the
    standards of living of the average peasant in the Yangzi delta, the
    average peasant in the Rhine valley, the average peasant in the Nile
    valley, and the average peasant in the Ganges delta were small: a
    factor of two at most. Malthusian population pressure kept
    populations high enough to push average standards of living
    worldwide close to subsistence, and more natural resources or better
    technology showed up much more in higher population densities than
    in higher standards of living.

    Then the world changed, and the industrial revolution came.
    Technological progress accelerated to become fast enough to outstrip
    population growth and generate rising standards of living. As
    standards of living rose, death rates fell and birth rates fell as
    populations underwent the demographic transition to low fertility
    and low rates of population growth even when very rich. The world
    became an enormously richer place.

    However, over the past two centuries the world also became a much
    more unequal place. Economic growth in the industrial core vastly
    outstripped economic growth at the periphery, so that the gulf
    between rich and poor worldwide widened to an almost unbelievable
    extent. The purchasing-power-parity gulf beween per capita income in
    the United States and in India today is not a factor of two but a
    factor of twenty. It is not that Indians are poorer than their
    predecessors of two centuries ago: today in India almost no one dies
    of famine; there is one television for every four households, and
    one radio for every two households. But standards of living and
    levels of material productivity in India have grown only a tenth as
    fast as standards of living in the developed industrial core.

    That was the pattern of worldwide growth up until 1975: increasing
    wealth but also increasing inequality on a global scale. That was
    the pattern that has changed since because the 1980s and 1990s were
    very good decades for economic growth in the world's two
    largest-population countries: India and China. As best as we can
    estimate, India's real GDP per capita at constant prices has grown
    at an average of four percent per year over the past two decades--a
    pace at which per capita income doubles every eighteen years. As
    best as we can estimate, China's real GDP per capita at constant
    prices has grown at an average of seven percent per year over the
    past two decades--a pace at which per capita income doubles every
    decade. Today's inhabitants of China have about four times the
    material standard of living of their predecessors of only two
    decades ago. Nearly two and a half billion people in these two
    countries have seen their material standards of living and
    productivity levels increase remarkably.

    China has achieved such rapid growth by dismantling the Maoist
    regime of economic central planning and by focusing on building a
    market economy, encouraging exports, accelerating education and
    technology transfer from abroad, and also by using local governments
    as decentralized engines of entrepreneurship.

    India has achieved less rapid but still impressive growth by
    following a policy of what can only be called "neoliberalism": try
    hard to shrink the size of the state, try hard to shrink the
    magnitude of the state's bureaucratic intrusions into the economy
    (abandoning the requirements that investments be licensed, for
    example, and that private enterprise be forbidden from entering
    certain sectors), reduce tariffs, and encourage increased
    international economic integration. Stanford economist Charles Jones
    pointed out in the early 1990s that for most of the Nehru-Gandhi era
    India's internal structure of prices had been such as to make
    investments to boost economic growth very expensive, thus there was
    plenty of room for policy reform not to "get prices right" but just
    to get prices less wrong.

    In both countries these shifts in economic policy in the past
    quarter century have been extraordinarily successful, although in
    China more successful than India.

    It is this growth in these two countries--the transformation of
    China from desperately poor to poor, and the transformation of India
    from desperately poor to extremely poor--that has for the first time
    in at least two centuries narrowed the proportional gap between rich
    and poor. It has for the first time in at least two centuries made
    the world a more equal place.

    Why, then, has no one noticed? Why are our newspapers full of
    reports of growing economic gulfs between rich and poor in our
    world? And why are they full of reports of the crisis of a model of
    economic development that does not serve the interests of the
    world's poor?

    I believe that no one has noticed--or rather, surprisingly few in
    the first world have noticed--for two reasons. First, first-world
    newspapers focus on the first world. Widening income and wealth gaps
    between silicon plutocrats and industrial and service workers within
    the first world attract much more coverage and ink than does
    anything happening outside the boundaries of the industrial core.
    Widening income and wealth gaps within the first world are indeed
    important. But they are not the only thing worth focusing on.

    Second, China and India are only two countries. At international
    meetings their nearly 2.5 billion people get only two voices. There
    are 49 other countries classified by the World Bank as "low income."
    They, collectively, have less than half of the population of India
    and China. But they have 25 times the number of delegates. And many
    of these other low-income countries' economies have been doing very
    badly indeed over the past two decades. Their poor performance and
    their troubles thus get much more attention than the dual successes
    of India and China. The typical experience of a person in a poor
    developing country over the past two decades has been much better
    than the typical experience of a country, because the typical person
    lives in China or India.

    Whether we assign China and India to their proper place plays a key
    role in how we assess world economic progress over the past quarter
    century. No one disputes that the liberal world market economy
    delivers faster productivity and total output growth than
    alternative systems. Centrally-planned states have managed to invest
    more and grow faster for short periods only, and at immense and
    unacceptable human cost. But the Achilles' heel of the liberal world
    market economy has always been the sense that it fails massively
    when it comes to distributing the fruits of better technology and
    higher investment--and the steady widening of world income
    inequality before the mid-1970s was powerful evidence that this
    critique could not be readily dismissed.

    But now it is much harder to argue that the world economy is
    permanently bound to produce slower economic growth in poor
    countries than in rich countries. The economic growth record of many
    poor countries--nearly an entire continent's worth in Africa, many
    in Latin America, some in south Asia--over the past quarter century
    has been awful. The success of Indian and Chinese growth over the
    past two decades makes the failure of economic growth to take hold
    in other very poor countries even more heartbreaking. Most of their
    people have not yet found a place on the escalator that leads to
    modernity. But cast your mind back a generation and remember how
    poorly India's and China's economic growth prospects were then
    viewed. It should be no more difficult to spark economic growth in
    the next generation for this final group of about one billion people
    who have not shared significantly in world economic growth.