The fuel of discontent: hyper globalization causing a growing income inequality

PwC Europe’s chief economist Jan-Willem Velthuijsen discusses income inequality with top ranking economists Branko Milanovič en Dani Rodrik

Dani Rodrik and Branko Milanovič are world famous for their work on how globalization and income-inequality help to create a world of discontent. But why and when went globalization out of control, and what can be done to compensate for the growing income inequality – the biggest economic, social and political challenge of today.

Who are Dani Rodrik and Branko Milanovič?

Dani Rodrik is professor of International Political Economy at Harvard John F. Kennedy School of Government. His thesis on The Globalization Paradox (2011) became a bestseller and made him one of the most debated and quoted economists of his time. In Economic Rules: the Rights and Wrongs of the Dismal Science (2015), he blamed his fellow-economists to have become the ‘cheerleaders of globalization’. And in his latest, Straight Talk on Trade: Ideas for a Sane World Economy (2017) he lashes out to a globalizing world that stays blind for the inevitable clash between national sovereignty and the demands of international trade.

Branko Milanovič is visiting presidential professor at the Graduate Center of Economics at City University of New York and senior scholar of the Luxembourg Institute of Income Study. Since the publication of his latest work, Global Inequality: a New Approach for the Age of Globalization (2017), he is the but one (Thomas Piketty) most quoted economist on income inequality in a globalizing world.

"Most of my colleagues were sceptical about my theory, but now, they too feel that it is striking how the trilemma has become real."

Dani Rodrik

- Can you first tell us how the globalization trilemma has deepened since your works?

Rodrik: "When I first wrote about the trilemma, I thought of it as merely a theoretical abstract. We cannot simultaneously pursue democracy, social inclusion, national self-determination and economic globalization. At some point there will be conflicts with the international demands of globalization, and that is when national priorities should take precedence. Most of my colleagues were sceptical about my theory then, blaming me for supporting protectionism. But now, they too feel that it is striking how the trilemma has become real since. We see how globalization is shaping bargains on a binational level. The Brexit, and the election of Trump, are very deliberate attempts by non-centric political groups to take political power by saying: you need our national sovereignty to claim what the elites have promised you, but you are not getting because globalization has gone hyper. These political groups gain momentum and are willing to close their borders to make their point."

Milanovic: "Our income developments depend more and more on international scales and considerations. But when the outcome doesn’t satisfy us, there is no-one to go to. The addressee to this problem is not actually the political space that created the problem. So, the reason that you are low payed or unemployed lies in the space of the world. That is a hard message to digest and it creates a growing political space for populism and extremism. In the past you could at least address national politicians and national institutions and expect results, now there is a mismatch on a global scale. We see this political disconnect grow bigger and bigger."

- Are technology and globalization working together to increase the income gap?

Milanovič: "Technology and globalization are the main driving forces behind the second Kuznets-wave we see in modern societies today. The first was triggered by the innovations that brought us the Industrial Revolution, the second is powered by digital innovations that become available to everyone because of globalization. Globalization is increasing the profitability of innovations and exhilarating technological and social change. Take for instance our iPhones. Because they are produced at minimum wages and at low costs in China, they became accessible to everybody. Because of this, we could create app-platforms that have such a huge impact on our lives, how we organize ourselves, and what we know from each other since. This would never have happened if they were only produced in the US. This development helps to expand the income-gap worldwide. Who has become very rich the last 20 years? The platform companies that didn’t exist 20 years ago. The people involved benefitted from huge rents and the rise in the market capitalization form those companies. Most others didn’t. There is a huge shift in the way we organize and distribute work and jobs because of digitization and robotics. Inevitably, there will be winners and losers. At the same time, globalization is playing a limiting role too. It doesn’t allow you on a national level to limit the export of capital and of skilled labour by taxation. However, it does limit what you can tax large corporations. So, fighting inequality is much harder in the current conditions of a globalized world."

Rodrik: "Globalization has made capitalism an export product. Because capital is under a continuous threat of leaving, there are serious restraints on wages and tax arrangements. Trade agreements have a disproportionally large impact on the welfare and wellbeing of low skilled workers anywhere on the globe. The norms about payment are globally inspired, labour markets are connected, technology is widely available and accessible. Globalization is the undercurrent that connects all these developments, and together they create a pressure cooker effect on a national scale. That is my definition of hyper globalization: globalization that creates more negative side effects than we wish for and can control with the political and economic instruments we currently have."

"There is a huge shift in the way we organize and distribute work and jobs because of digitization and robotics. Inevitably, there will be winners and losers."

Branko Milanovič

- Is Europe closest to hyper globalization?

Rodrik: "The European version of hyper globalization has gone the furthest, in the way that the EU-countries feel its effects the strongest. Because they have integrated themselves only economically. There is open border trade and a significant convergence of regulations and standards. There is deep integration of markets and services, there is a single currency and a single central bank, there are free financial flows. This is as close as anyone in the world gets to hyper globalization. And yet, while all this is happening, the European governments haven’t made explicit choices. This clashes. You can’t have all these benefits from a single market and say: don’t you worry, people, this won’t influence our democracy and national sovereignty in any way. That false promise has come back to hunt the political elites. In some sense it is the reason, I believe, for the populist backlash we see in so many European countries."

Milanovič: "The political turmoil we see today in Europe and the US, is basically the result of a lack of growth of their middle classes. There is convincing evidence that middle class-income has not declined (as some say), but that they certainly have gained less than others. The outcome is consistent with the political world we face. Look at the voting records; the people who voted pro-Trump, pro-Brexit, pro-AfD and other anti-mainstream parties, did so because they are disappointed in the outcome of globalization and technological change in their personal situation. The political-cultural channel is the channel in which this economical discontent is being conveyed. Still, many politicians are not fully aware of this. By not addressing the negative effects of globalization on large segments of the working class, they fuel extremist views. You see it in Trump’s America. In France, Le Pen has the most support under the working class in the impoverished regions that used to strongly support the communist party some years ago. The AfD in Germany has its most supporters in the former communist DDR."

- Is the Brexit also in line with the script of the trilemma?

Rodrik: "Yes, it is. The brexiteers won by demanding a Europe à la carte. They still want free trade, they still want a single market and they still want passporting of services. But they don’t want to give up their sovereignty, they don’t want a single labour market, they don’t want a EU-tax system, and they do want to keep their own currency. The Brexit is the sort of customized claim one can expect as an answer to hyper globalization. It is a bit weird tough that Britain goes first; of all EU-members they have the most opt-outs for the trilemma. They were not even a part of Schengen. That the UK fell into this position, is due to the fact that the political elite slavishly persisted in pursuing old ideals. Brussels did too. There are lessons to be learned here for European leaders: if you don’t address these feelings of discontent, and offer political solutions that appeal to the groups that feel excluded, they lash out in a chaotic and uncontrolled way and seize their own political momentum. I am afraid that once the disappointment sets in, the Brexit process shall backfire in a big way. European politicians can use this as a warning for what can happen, but I am afraid they shall miss on this one too. Europe is too caught up in its own dilemma: trying to achieve what would be most desirable in the long term: completing the EU with greater political stability and inclusive institutions, while keeping the populistic movements satisfied at the same time. The two don’t mix, as the current Brexit-negotiations show. They are not about creating the best future economic and social environment for both parties, no, they are about who is picking up yesterday’s bills."

- What would you suggest to restore the social equilibrium?

Milanovič: "We must rephrase the problem, and address it differently. Normally we start to correct the inequality outcome by redistributing wealth from the haves to the have-nots via taxation – most governments are doing this now or are planning to. But if we start working on the long term equalization of endowments and of the development of human capital, you don’t need tax reforms and the often unpredictable political debates it comes with. The de-concentration of capital is necessary, however. Capital is very concentrated: 1 percent of the people in western societies having 50 percent of financial capital. And still there are only tax incentives for big investors. It will help narrow the bridge, if one designs tax incentives for small investors in the middle class and provides guarantees that their invested money will not be negative. Furthermore, compensate all workers partly with shares in their companies via stock option plans. Secondly: we need the equalization of human capital. This implies, for the US and Europe, preserve equality in access to education in all stages of one’s career and against similar costs. The Taiwan-example proves that if you have relatively low inequality in endowments, you have low inequality in market-income. It also shows that you don’t need a huge corrective role of the state, with all politics involved. So, by reducing the inequality of endowments, you reduce the responsibility of the state in this also. And that makes this solution appealing to both right and left wing politics."

"Trade agreements should shift more to tax harmonisation, labour mobility, standardizing diplomas and salary scales, tackling social dumping. If you harmonize these, you reduce income inequality."

Dani Rodrik

Rodrik: "Look at the role of trade agreements. They have become more about control than about expanding the world economy. They should shift more to tax harmonisation, labour mobility, standardizing diplomas and salary scales, tackling social dumping. If you harmonize these, you reduce income inequality."

-  What can corporates do?

Milanovič: "Unlike climate change, there is very little one can do on an individual scale. Accepting global income-scales would help, but no company can accept this because of fear for losing competitive advantage. Giving to charity is no sustainable solution either. No, this is primarily a political challenge. The best companies can do is to use their influence to steer the political debate by pointing out that reducing inequality is best for their continuity in the long term. And to be better heard and trusted, you can set an example in ethical hiring and pay – for instance by reducing the gap in pay between top executives and the average pay of the rest of the workers."

"You don’t need a huge corrective role of the state, with all politics involved. By reducing the inequality of endowments, you reduce the responsibility of the state in this also."

Branko Milanovič

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Jan Willem Velthuijsen

Jan Willem Velthuijsen

Chief Economist, PwC Netherlands

Tel: +31 (0)88 792 75 58

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