The Causes of Wealth Inequality (5): Globalization

Globalization is supposed to have lowered the earnings of less-educated workers by putting them in direct competition with low-wage workers around the world. This competition put pressure on wages through international trade in goods and services; through the relocation or threat of relocation of production facilities to overseas locations; through competition with immigrants in local labor markets; and through other channels. …

U.S. and European workers are told that … our societies can no longer afford a generous welfare state. …

Contrary to the standard framing, which presents globalization as something that no nation can escape or even attempt to shape, we can choose the terms under which we integrate capital, product, and labor markets across countries. Over the last 30 years we have indeed “chosen” a particular form of globalization in the United States – a form that benefits corporations and their owners at the expense of workers and their communities. If we had chosen globalization on different terms, however, economic integration would not have required rising inequality. Another globalization is possible. (source, source)

So globalization, as it has occurred and is occurring, causes higher inequality in the West in two ways:

  • The direct competition with overseas workers who can produce at lower wages puts downward pressure on wages in the West, especially for low-skilled workers at the wrong end of inequality.
  • Governments in developed countries react to this competition by restricting social safety nets because the taxes necessary for the funding of these safety nets hurts the competitiveness of local businesses, a competitiveness already under pressure from low-cost labor in the developing world. Less generous safety nets obviously also have a negative effect on inequality.

If these effects are real, perhaps they can explain the decline of manufacturing in many developed countries.

However, I’m not sure this pressure on wages is real and significant (I’ll try to find some data), and we also shouldn’t dismiss the benefits for low-wage workers in the West of cheaper products. This particular result of globalization can offset the possible negative wage effects of wage competition.

Also, I’m not sure governments in the West are actively attacking safety nets (here it says they haven’t during the last decades, but it seems that the recent economic crisis has convinced some to start cutting benefits). And finally, we should remember that inequality isn’t just a national problem. The inequality between countries is just as, if not more, important. And globalization has had a beneficial effect on inter-country inequality because it has redistributed wealth from rich countries to poor countries. For example, it’s hard to imagine how China could have had the same success in poverty reduction without globalization. The question is of course whether this redistribution had to come from low skilled workers in the West, rather than from their more wealthy fellow citizens. The fact that it did come, however, was undoubtedly beneficial to the poor in the receiving development countries.

Economic Human Rights (32): The Economic Cost of Taxing the Rich

Taxation is linked to human rights in several ways:

I personally belief that a progressive tax is best in light of the last two concerns. In a progressive taxation system, higher earners pay a larger percentage of their income on taxes. Compared to a regressive taxation system (people with higher incomes pay less in percentage of their income, as in the case of a consumption tax or VAT) or a flat tax (the tax percentage is the same for all income groups), a progressive tax reduces income inequality: it makes incomes more equal in a direct way because it reduces the income of higher-earning families by a larger percentage than the income of lower earning ones; but also in an indirect way because this system – under certain conditions – yields more tax revenues which can then be spent on poverty reduction and the safety net. Also, it seems to be a good example of a just and fair system. The strongest shoulders should carry the most heavy burden. Someone earning a low income can end up in poverty after paying a small percentage in taxes; a wealthy person will perhaps not even notice paying a relatively large sum in taxes.

The counter-narrative states that high tax rates discourage people; they are a disincentive to hard work and effort. High tax rates for high incomes discourage people who work relatively hard (they work hard supposedly because they earn a lot). Because high tax rates punish the most productive elements in a society, the whole of society suffers. More productive people will limit their productivity because they don’t want to fall into a higher tax bracket, and the money they pay in taxes can’t be invested in the economy. Taxing the rich therefore has an unacceptable economic cost. Conversely, low tax rates for the rich produce benefits for all (this is trickle down economics, read also about the Laffer curve).

But this narrative doesn’t quite stand the test of data. As is clear from this link, high tax rates don’t slow down economic growth, and low tax rates don’t speed it up. This paper also supports the claim that moderate, as opposed to dramatic, increases in marginal rates don’t have any impact on the willingness of the wealthy to participate in the economy. They won’t go Galt. Atlas won’t shrug, except to signal indifference.

The top income tax rate was 91% (beginning at taxable income of $400,000) … [in] the period from 1951 through 1963. Those were the golden years of the U.S. economy, in which the average annual rate of productivity growth was 3.1% (compared with about 1.5% after 1981). Of course, the growth might have been even faster had the marginal tax rates been lower, but the coincidence of high rates and high productivity raises challenging questions for those who believe that high marginal tax rates carry an unacceptable cost. (source)

To be fair, marginal tax rates are a crude measures of tax burden. There’s a difference between marginal tax rates and effective tax rates.

  • A marginal tax rate is the tax rate that applies to the last dollar of the tax base (taxable income or spending, usually income). It’s not the rate at which all your dollars are taxed. It’s the maximum rate you’re paying on any of your dollars of taxable income.
  • An effective tax rate refers to the actual rate, i.e., the rate existing in fact, for the entire income, after tax deductions and credits and taking into account lower rates for lower income brackets (see here). It’s your total tax obligation (including your income tax and any other additional taxes and/or credits), divided by your total taxable income.

But even if we look at the effective tax rates of the rich, we see that this has steadily decreased over the decades, with little or no positive effect on overall economic performance.

And when there’s no positive effect of decreasing tax rates, there’s probably also no negative effect of increasing tax rates. To the extent that the wealthy (and productive, although those groups obviously don’t overlap completely) respond to changes in the tax system, their responses focus not on increased/decreased labor, productivity or investment, but on tax avoidance (see here).