The Relationship between Globalization, Economic Growth and Income Inequality

The Relationship between Globalization, Economic Growth and Income Inequality The Relationship between Globalization, Economic Growth and Income Inequality
Authors: Heshmati, Almas; Lee, Sangchoon
Journal: Journal of Globalization Studies. Volume 1, Number 2 / November 2010

This study investigates the relationship between globalization and income inequality by developing a new globalization index based on economic growth. In addition two other indices of globalization, non-parametric Kearney and parametric principal component analysis are used as benchmarks to compare the results. The proposed new index is decomposed into four sub-components. The index is also estimated in several forms separated by different economic growth variables and in decomposed or composite forms. The main feature of this approach is that the estimation of globalization index and the examination of its relationship with economic development are conducted in one step. All indices are compared in respect of their level, development and correlations. The empirical analysis is based on a panel data consisting of 61 developed and developing countries observed during the period 1995–2001. Regression analysis is used to estimate the effects of globalization on income inequality. To examine the sensitivity of the relationship between globalization and inequality, different inequality variables are employed. It is expected that the indices serve as useful tools in comparing the globalization process among countries and the evaluation of the globalization effect on economic development and income inequality. This study is useful in the construction of a new multidimensional index of globalization with different and estimated weights attached to the determinant factors.

Keywords: globalization, income inequality, economic growth, index.

1. Introduction

Globalization can be defined from various aspects not only in respect to economic activities, but also to political, technological, cultural interactions and taking into account many key factors such as standardization, transportation, communication, trading, migration, etc. Through the process, economies become closer and more interrelated. As countries are speeding up their openness in recent years, there have been increasing concerns related to the globalization and its impacts on issues such as economic growth, poverty, inequality, regional differences, cultural dominance, environment, or economic integration. Countries with large heterogeneity in the degree of globalization have shown different development patterns and results. The different degrees of development have become a source of inequality or poverty. Thus, the link between economic growth, inequality, poverty and globalization has become the focus of attention of many researchers.

Despite the increasing interests in the influence of globalization on economic growth and inequality, there are not many empirical studies examining the links between them. The limited empirical evidence is a result of a lack of theoretical development, limited data and unsatisfactory measures of globalization. In recent years, several researchers have been developing methods of measurement of globalization to test the relationships mentioned. The limited evidence also suggests contradictory views on the issue. For instance, some argue that globalization provides benefits by enhancing economic development and the reducing inequality of people with high economic opportunity, while others are against globalization due to its restricted beneficiaries. In general there is an agreement that globalization increases inequality but it reduces poverty while its regional concentration increases. Such development has been observed in India and China.

Currently there is no standard rule of measure and measurement of globalization. The need for research in this area has recently attracted great attention. Several attempts have been made to quantitatively measure globalization. Different measures ranging from single measures like trade to multidimensional measures with different coverage of various aspects have been produced. The differences are attributed to the availability of data and the technical skill of the researchers. The globalization index can indicate the level or the progress of globalization of countries which is also in turn changing over time. The globalization index can be employed to quantify its impact on the difference in development or integration of countries, and the index can be used to study the causal relationship between globalization, income inequality and poverty. In addition, the international levels of globalization can be compared over time and across regions to investigate inter-regional and intra-regional comparisons of openness.

The main purpose of this study is to investigate the relationship between globalization and income inequality by developing a new globalization index based on economic growth. Two existing indices of globalization, the Kearney and principal component analysis, are used as benchmarks to compare the results. The proposed globalization index is decomposed into four sub-components suggested by the Kearney index. The new index is estimated in different forms separated by different economic growth variables. The main feature of this model is the estimation of the globalization index and examination of its relationship with economic development, which is conducted in one single step procedure. To examine the sensitivity of the relationship between globalization and inequality, we employed different inequality variables in the different models. All indices including the newly suggested index are compared in respect to their level and development. Various variables employed in the models provide sufficient flexibility to assess the measure and impacts of globalization. It is expected that the indices provide useful tools to compare the globalization process among countries and the evaluation of the globalization effects on the economies. This study can also be useful in the construction of a new index of globalization considering the multidimensional nature of the issue and different weights attached to the determinant factors. The empirical analysis is based on a small panel data consisting of 61 developed and developing countries observed during the period 1995–2001. Regression analysis is used to estimate the relationship between income inequality and globalization intensity.

This paper is organized as follows. The literature review on the links between globalization, economic growth and inequality follows in section 2. In section 3 the used data is described. In section 4 previous indices including composite Kearney and principal component-based indices are described. The development of the indices over time and regions is also illustrated and discussed. In section 5, the new index of globalization, based on different component system and its relationship with different economic growth variables, is introduced. Section 6 includes not only index values, but also the rankings of countries, the regional differences of globalization, and the development of globalization over time. The impacts of globalization on income inequality estimated through regression analyses with various inequality variables are discussed in section 7. Finally, section 8 summarizes the results and concludes this study.

2. The Literature on Globalization, Growth and Inequality Relationships

The interest in and amount of research on the relationships between globalization, economic growth and income inequality has been increasing in recent years. The growing interest is a result of the rapid development of international relations and the speed at which the recent wave of globalization is proceeding. The theoretical literature on each component is vast but the empirical evidence on the nature and causal relationship between the different interrelated factors of interest remains poor. Thus, there is an urgent need for further research and methodological development at different levels and aspects to shed light on the issues.

Recently, there have been a limited number of studies on different combinations of the links between key factors of interest such as inequality, poverty, growth, trade and globalization. Aghion and Williamson (1998) study the links between globalization, growth and inequality, while Collier and Dollar (2001) examine the relationships between globalization, growth and poverty. Mahler (2001) shows little evidence of a relationship between economic globalization and the disposable income or earnings of households in the case of developed countries. Mayer (2001) mentioned that globalization gives benefits even to the poor countries for instance in the form of access to new technologies and opportunities, while countries show different technology, skill absorption and development abilities. Manasse and Turrini (2001) examined the impacts of globalization on inequality through trade integration, while Miller (2001) argues that globalization leads to a significant increase in income inequality.

Lindert and Williamson (2001) state that globalization has very different implications for inequality in a country. The authors classify the effects of globalization on inequality into five categories within and between countries. Among the effects, one is that a greater degree of globalization has reduced inequality. Talbot (2002) argues that a new international inequality has been derived through the old style of international inequality, which explains the increasing global inequality. The nineteenth century globalization was one of the most important reasons of increasing international inequality in the study of Bata and Bergesen (2002a, 2002b). Ajayi (2003) concludes that integration combined with other factors, like the maintenance of macroeconomic stability, the development of human capital, high investment ratios, infrastructure and institutions, can enhance economic growth. Mussa (2003) examined issues related to the distribution of benefits from increasing globalization activity. In general the focus on economic growth has changed from identification of factors generating growth and convergence to how growth is distributed in an economy. Heshmati (2006c) reviews the economic literature on the world distribution of income and income inequality. The exiting research supports increased awareness of the problem, its measurement and quantification, the identification of causal factors and policy measures that affect global income inequality.

Concerning the measurement of globalization, Heshmati (2006a and 2006b) introduces two composite indices of globalization. The first is based on the Kearney/Foreign Policy magazine and the second is obtained from a principal component analysis. They indicate the level of globalization and show how globalization has developed over time for different countries. The indices are composed of four components: economic integration, personal contact, technology and political engagement, each generated from a number of indicators. A breakdown of the index provides possibilities for identifying the sources of globalization at the country level and associating it with their economic policy measures. The empirical results show that a low rank in the globalization process is due to conflicts, economic and technology factors with limited possibility for the developing countries to affect. The high ranked developed countries share similar patterns in distribution of various components. The indices were also used in a regression analysis framework to study the causal relationships between income inequality, poverty and globalization. The results show evidence of a weak and negative relationship between globalization and income inequality and poverty. Regional location explains most of the variations in income inequality and poverty among the sample countries.

Dreher (2006; see also Dreher et al. 2010) concludes that globalization promotes growth by giving results that more globalized countries show a higher economic growth rate, while the lowest growth rates are attributed to those who are not globalized. Thus, the result from limited data suggests positive association between openness and economic growth. Summers (2006) acknowledges that globalization, in addition to positive effects, has adverse effects like increasing inequality.

In a recent collected volume sponsored by WIDER-UNU, consisting of studies in development economics and policy by Nissanke and Thorbecke (2007), the impact of globalization on the world's poor by focusing on transmission mechanisms is presented. The volume is a serious attempt to better understand the major links and to document some of the main transmission mechanisms. There are also other pieces of research that have explored those mechanisms. Among others Harrison (2007) compiled a work sponsored by the NBER on globalization and poverty; Hertel and Winters (2006) developed a model of world trade to explore the same issues; and Hoekman and Olarreaga (2007) inspected the same mechanisms at a micro level. These books complement each other extremely well and will help policymakers in their objectives for the achievement of the Millennium Development Goals and eradicating poverty.

3. The Data

The database created by Kearney is the first unique one used for the computation of the globalization index. The data is a small panel data covering 62 countries observed during the period 1995–2000 but updated on an annual basis. It was collected from various secondary data sources such as national sources, international organizations and financial institutions. In this study, we expanded the period to 1995–2001, which is composed of 61 countries and has a total of 427 observations.1 The index is composed of four main components. The four components are the same as those of the Kearney index. Economic integration, personal contacts, technology, and political engagement are selected to represent globalization which affects the economic performance of countries and the living conditions of their citizens.

In order to assess the effect of globalization on the economy of the countries and their citizens, several normalized economic and economic growth variables such as GDP, GDP growth, GDP per capita and growth in GDP per capita are included. Table 1 shows summary statistics of the four components of globalization, GDP-based economic growth variables and the various globalization indices, including Kearney indices and principal component-based indices. We can see large variations in the index components and GDP values which affect the calculated indices. The mean values of GDP and GDP per capita are much higher than the median values with large standard deviations which show evidence of skewed distribution of GDP levels. The growth rates are more evenly distributed. The large dispersion of components makes the mean and median value differ. Only the political component has similar mean and median values.