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What drives between-country inequality?

Posted By Martin Duys, Tuesday, February 11, 2020

Martin Duys, a member of our Emerging Fellows program inspects the drivers of inequality among countries in his second blog post. The views expressed are those of the author and not necessarily those of the APF or its other members.

 

The factor that plays the most critical role in determining a person’s income is the country in which they live. It has more influence than the persons parents’ economic circumstances (the second most important factor) and far more than any effort they may make to improve their situation through education. Geography is more important than class, or level of education, in determining income.

 

Between-country inequality has never been as extreme as now. Just before the start of the industrial revolution, the average income in the wealthiest countries (at the time Holland and the United Kingdom) was roughly three times higher than the poorest. Described as analogous to the ‘Big Bang’ rates of economic growth and average incomes exploded in countries that industrialised. Now the difference in average income between the rich industrial nations and those that have failed to industrialise is a multiple of one hundred.

 

From the second half of the twentieth century other factors have also contributed to driving between-country income inequality. The political and institutional instability experienced in some countries after decolonisation caused economic stagnation and in some cases, decline. In the Soviet Block and other socialist countries, socialism failed to lift income levels significantly.

 

There are factors driving a decrease in between-country inequality. Sustained economic growth since the 1980s in China and India has had an enormous impact. In China alone, the number of people whose incomes have doubled is ten times that in the United States over the same period.

 

In gross terms, the gap between rich and poor countries continues to grow. China's economy would need to grow by eighteen per cent to generate the same value created by a one percentage point increase in the GDP of the United States. This is an almost impossible task for any economy no matter how ‘on fire’ it is.

 

An assumption of neoclassical economics has been that globalisation would improve levels of between-country inequality. Poor countries with cheaper labour forces would attract more foreign direct investment (FDI), because corporations looking to increase returns by lowering production costs would invest. The result would be increased local income levels and decreased inequality. Emerging countries would also ‘slip-stream’ on the technological advances of richer countries by copying their innovations and avoiding the need for expensive research and development. They would also be able to avoid adopting dead-end technologies that proved unsuccessful or were quickly superseded by superior technologies. Unfortunately, these assumptions have not been borne out by reality.

 

In what is termed the “Lucas paradox” FDI has not flowed as expected from high-income to low-income countries. Instead, it has to tended to flow from high-income countries to other high-income countries, and even from low-income to high-income countries. Technology adoption by developing countries has not been an equaliser as expected. Royalty payments for new technologies tend to flow from the poorer adopting countries to the more affluent countries that own the intellectual property.

 

The failure of the focus is shifting to include institutional and cultural considerations. The goal is to create an environment fertile for innovation, technology, and economic growth. Whether this new approach improves levels of between-country inequality remains to be seen.

 

© Martin Duys 2020

Tags:  country  economics  inequality 

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