Elephants, globalisation, and why we shouldn’t let domestic policy makers off the hook on living standards

Published on Incomes and Inequality

From political rallies to university seminars, it is becoming fashionable to say that globalisation has led to stagnant living standards for working and middle classes of the developed world, leaving national governments powerless to deliver rising incomes and explaining rising political dissatisfaction with the status quo.

But these are dangerous words in such simple form, because they are both wrong and getting at something. Living standards in Britain and in many developed countries have seen phases of being squeezed. But we should beware concluding that responsibility for that rests entirely with a faceless force called globalisation – that if we reversed would put right all that is wrong with the world.

This question is not new. But the recent British decision to leave the European Union, the prominent place for trade policy in the end game of the current US presidential cycle and phoney war phase of national elections in France and Germany, means the issue has not just risen up the agenda – it is becoming the agenda in much of the developed world.

The debate across the West

Crucially this is a debate in flux – and where it settles will matter for our politics and economics for decades to come. In the face of popular frustration progressives are rethinking where they stand on questions from trade to migration. In the US a Democrat President is pushing trade deals that cross both the Pacific and Atlantic, amidst a growing debate in his own party about the very desirability of free trade in the first place. Both Francois Hollande and Sigmar Gabriel have adopted significantly tougher rhetoric against the same trade deal between the EU and USA that Obama champions. The British Labour Party faces the challenge of redefining its vision of Britain’s role in a post-Brexit world. Owen Smith, the challenger in the Party’s current leadership election, favours another public vote on EU membership, while Jeremy Corbyn, the leader he is challenging, seems to view the Single Market as a ratchet to drive down labour market standards, rather than as the collective mechanism of relatively rich European countries for avoiding exactly that.

On the right, Donald Trump has reversed overnight the Republican traditional advocacy of free trade, instead seeing it as a danger to working people second only to Mexican migration. Or as he puts it “this wave of globalization has wiped out totally, totally our middle class.” Taken together, this is what flux on one of the central question of political economy looks like.

Does the evidence support the case against globalisation?

So is it right that globalisation has coincided with income stagnation for working people in the developed world? These are global questions, so answering them requires global data. The seminal contribution in that regard comes from Christoph Lakner and Branko Milanovic, bringing together an unprecedented collection of information on income levels across countries and using it to examine the period of ‘high globalisation’ from  1988 until the start of the global financial crisis in 2008 in a series of articles, and in Milanovic’s case a major book. These run to hundreds of thousands of words, but it is one chart which has made the work well known. The so-called ‘elephant curve’ has generated sufficient excitement to be described as possibly “the most important chart for understanding politics today”.

Replication of the Lakner-Milanovic global growth incidence curve (‘elephant curve’), 1988-2008

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Source: RF analysis of Lakner-Milanovic World Panel Income Distribution
Notes: Axis is cut off at negative 20 per cent

This chart (compared to an elephant, with the tail on the left representing the poorest in the world and the trunk on the right the richest) shows how incomes have grown between 1988 and 2008 for each part of the global income distribution. The key conclusion many have drawn from it is that, while these two decades saw good income growth for many (think China and the plutocrats), the working and middle classes of the developed world saw precisely zero income growth. It is this shocking conclusion that has made the curve about as famous as you can get while being an economics chart rather than a film star.

The only problem – as a new Resolution Foundation report shows today – is that the conclusion is wrong. There are two key points worth emphasising – the importance of demography and which countries experience we’re talking about.

Demographic headwinds

The chart compares the average income of, say, the top 1 per cent in the world in 2008 with the top 1 per cent in 1988, and so on for each per cent of the global income distribution. But crucially who is in each per cent changes during that period. This matters because population growth has been much faster in poorer countries, giving us relatively more poor and fewer rich people. This drags down the income growth reported in the elephant curve significantly but tells us precisely nothing about what has happened to working people in Preston or Pittsburgh. If we correct for this fact we find that incomes of the working/middle class of the developed world rose by around 25 per cent rather than stagnating.

Exceptional good and bad country performances

If we then dig into the big variation between individual countries it becomes clear that even this weak income growth is not a universal feature of low and middle income people in developed countries, but instead driven by the experience of Japan (where the data appears to be plain wrong) and ex-Soviet satellite states (who faced big income falls as the Soviet Union collapsed). These income changes are important, but again tell us very little about income levels in Western economies. Indeed once we exclude those countries from the analysis the income growth towards the top of the distribution rises again to around 50 per cent over the period, or around 2 per cent a year, a long way from stagnation.

Illustrative version of the elephant chart, excluding certain countries and if the relative size of each country had remained unchanged, 1988-2008

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Source: RF analysis of Lakner-Milanovic World Panel Income Distribution
Notes: The excluded Soviet satellite and Baltic states are Bulgaria, Czech Republic, Estonia, Germany, Hungary, Latvia, Lithuania, Poland, Romania and Slovakia

It is true that the US has seen very poor income growth, with the rich benefiting the most from what limited growth there was. But that experience is to quite a degree one of US exceptionalism. Variation amongst the developed world should make us reluctant to accept that this is inevitable or simply driven by global forces.

The challenges of globalisation

Now none of this means that globalisation hasn’t brought challenges. While the data above is about averages, substantial increases in international trade (not to mention technological change) have translated into much tougher competition for real companies and real workers. Some sectors saw huge employment changes – think of leather goods manufacturing, where in the UK the numbers employed fell from nearly 200,000 in 1995 to just 60,000 ten years later. Domestic policy certainly needs to address these changes, not lecture people that everyone’s a winner from globalisation. That is particularly true when such effects are geographically focused.

Employment changes in selected manufacturing industries across the UK

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Recent research also shows that in both the US and UK workers in sectors most affected by Chinese imports had worse employment and wage experiences than others since 2001 – when the world’s most populous country joined  the World Trade Organisation. That makes the case for thinking hard about the rate of change of big shifts in trade patterns, but it is a very different thing to asserting that globalisation always delivers zero income growth for working people.

So both those saying globalisation automatically benefits everyone and those saying that developed world middle classes have seen no income growth are wrong. Perhaps most crucially, where individual countries lie in between those extreme positions is to a significant degree down to policy choices.

Looking more closely at income growth in the UK, yes there was slow income growth immediately before the financial crisis – but that living standards squeeze owed as much to the long-term failure to build enough houses and contain housing costs. Similarly looking at the recent past, lack of bank regulation had more to do with the unprecedented earnings decline post-2009 than anything else. For the future major benefit cuts for working families will dominate their living standards experience for the rest of this Parliament. Domestic policy matters. To fetishise globalisation as the cause of all our ills is to let too many domestic policy makers off the hook for decisions they make, for problems they leave unaddressed and for the lower incomes working people experience as a result.

The UK is now going to have to decide what it thinks about globalisation again, requiring a trade and migration policy that it has lacked for decades. We need to learn the right lessons from the past, recognising the challenges of openness, but not thinking it is the cause of all our evils. We must do more to share income growth, not least geographically, and recognise that wider domestic agendas are as least as important and within domestic control – financial regulation, industrial strategy, benefit changes and house building to name just a few. Someone else might be responsible for the past, but we control at least a decent chunk of our own future. We might as well shape it.

 

This post originally appeared on Prospect Magazine online