Stephen King: Give globalisation a human face

Most economists believe that globalisation is a good thing. By breaking down barriers between nations, globalisation leads to a more efficient allocation of labour and capital. Greater efficiency implies higher output and higher output, in turn, makes us all better off. That, at least, is the theory. Globalisation, however, incorporates a core paradox. It reduces income and wealth inequalities between nations yet it seems to increase these inequalities within nations.

Admittedly, this is a contentious issue. Economists in the US, for example, have yet to make their minds up about the primary causes of growing US income inequality. Some argue, for example, that income inequality has widened because, 30 or 40 years ago, there was a leap in the numbers of students entering higher education. Those who were lucky enough to have benefited from this investment in human capital (as economists charmingly put it) would, in subsequent years, have reaped higher returns, particularly if they were linked to the technology revolution. Those who did not benefit from higher education would have been left behind.

There is probably some truth in this argument, but I doubt it is the whole truth. Most of us will have come across graduates who chose not to cash in on their earnings potential. Equally, non-graduates have often done very well (whatever their faults, Jim Callaghan and John Major made their way all the way to the very top of the political pile). Moreover, some forms of education may be a waste of time, other than through their capacity to signal serious endeavour. How many PhD theses, for example, disappear without trace?

Personally, I find it remarkable that people are prepared to deny the impact on income inequality of globalisation. Efficiency and equality are not always happy bedfellows. Economists talk of efficiency in terms of Pareto optimality, which basically means it is not possible to make one person better off without making someone else worse off.

This, though, is not what society is about. If, for example, one person owned everything and everyone else was starving, this might be a Pareto-optimal outcome because the many could be made better off only by making the one greedy person worse off. It is possible, of course, that the greedy person would feel guilty about his monopoly over resources and choose to give some of his wealth away but, in strict Pareto terms, he would now be better off having assuaged his guilt and, therefore, the starting point would not have been Pareto optimal.

Societies, therefore, do not operate on the basis of efficiency alone. The tax and benefit system is typically designed to redistribute income from the rich to the poor (unless, of course, the government of the day happens to abolish the 10p tax rate). The pursuit of efficiency can easily conflict with individual human rights (I have no doubt that Roman slaves were used efficiently but I am not sure their rights were fully respected).

Efficiency, then, is not a good enough argument on its own in favour of globalisation. Moreover, even if it were possible to support the efficiency argument at the global level, it is a much bigger struggle to do so at the national level. Income inequality and its association with globalisation is, after all, now one of the major themes in the US presidential election. Both the Obama and Clinton camps have dropped hints – credible or otherwise – that they would wave goodbye to the North American Free Trade Agreement, not because it is inefficient but, rather, because it is increasingly being regarded as a threat to American jobs and wages (of course, by rescinding the agreement, poor Mexicans are denied the opportunities they might otherwise have enjoyed but poor Mexicans, unlike poor Americans, will not be voting in November).

Emerging economies are also struggling with ever-rising income inequality. The food price scare increasingly looks like it is an unintended consequence of the emerging markets' dash for growth. The hope was that rapid emerging market growth would drag ever-increasing numbers of people out of poverty by raising average living standards. If, in the process, food price inflation has been unleashed, the very poor will end up poorer still. The resulting social tensions then force governments to adopt policies inimical to globalisation: recent restrictions on rice exports, which contributed to a further upward spike in cereal prices, are but one example.

In Britain, there is also a growing sense that globalisation creates both winners and losers, highlighted by the image last week of road hauliers parking their trucks in swanky Park Lane in protest at the ever-increasing level of fuel prices (and, of course, from the publication of The Sunday Times Rich List).

Admittedly, there are plenty of green reasons for welcoming higher fuel prices, but green reasons do not explain higher prices: the cost of energy (and food) is rising in part because of the extraordinary growth in demand for fuel from China and other emerging economies. Partly reflecting these price increases on life's "necessities", the gap between rich and poor in the UK has been growing, in line with the experience of the majority of other countries.

Growing income inequality may not fatally undermine the case for globalisation, but it certainly threatens political support for it. Democracies have tremendous problems dealing with globalisation. It is all too easy to create institutions designed to protect the nation or region from the onslaught of competition from abroad, in the process leaving the world as a whole worse off.

It is no coincidence that the growth of democracies in the late 19th century was associated with the rise of nationalism. While it is absolutely right to give the people the vote, their choices inevitably will be limited mostly to their country's national interests, with not as much thought given to the interests of people elsewhere (those in the developed world who demand a level health and safety playing field would claim otherwise, but their approach really boils down to protectionism through the back door: health and safety are too often the rich man's preserve).

So where does this all leave globalisation? What is needed is a policy of enlightened globalisation, which accepts that efficiency gains can sometimes come at the expense of distributional losses. After all, people are, not surprisingly, suspicious of market solutions given the recent evolution of the credit crunch. They are less confident that they, individually, will benefit from a process that nevertheless makes the world as a whole a better place. And each individual country increasingly has an incentive to blame others for its woes.

Political leaders have, to date, done little to discuss what needs to be achieved in the form of income redistribution to ensure the losers from globalisation are compensated. That is partly because our leaders don't want to admit that globalisation may have unpleasant side effects. Their refusal to be candid, however, simply increases levels of distrust. By doing so, globalisation becomes even more vulnerable. We might, instead, end up with unenlightened protectionism.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com