Wednesday, April 22, 2009

Is Greater Inequality Desirable for Economic Development?

The following is an analysis of whether greater inequality is desirable for economic development. I begin by defining key terms. I then attempt to answer the questions:

1. What are some of the requirements of economic development?

2. Do these lead to or necessitate inequality?

Regarding the economic development factors I discuss - none of these is sufficient for economic development, nor are all of them necessary (nor is the list comprehensive). Instead, a mix of these is found in each developed economy, depending on other factors, such as the historical period. Finally, the factors can be categorized as environmental or human-related. Only a single factor, natural endowment, is not a direct result of human influence (with the exception of created comparative advantage and global pollution).

Economic development can be defined as an ongoing process of meeting the basic needs of a population and enhancing options for the allocation of resources both today and in the future to increase the choices citizens have in their daily lives, as well as their overall well-being.

Inequality can be defined as the degree of income disparity between the lowest and highest income groups (such as quintiles) in a population, as demonstrated, for example, by the Gini coefficient.

Natural endowments refer to any conditions bestowed upon a geographic area which can catalyze or slow economic development. Natural endowments can include oil and minerals, domesticable plants and mammals, geographical barriers (i.e. the Sahara or the Andes), natural disasters (such as droughts in Africa, flooding in Bangladesh, and tsunamis in Southeast Asia), and even a north-south versus an east-west geographical orientation . Human migration, for example, gave Eurasia a 5,000-year head start over the Americas (note that Africa’s head start did not make up for its geographical orientation and barriers). Thus, nonhuman factors set the stage for later inter-country inequality.

Some argue that democracy is not a requisite for social and economic development, claiming that, unless it is based on stable political and economic foundations (not common in most LDCs) it can wreak havoc on a developing nation. For example, an Iraqi citizen driving the wrong way on a one-way street explained, “We have democracy now. I can do whatever I want!” Another salient example is the contrast between the economies of Singapore (a restrictive non-democracy) and South Africa (a new democracy, which has high murder and inequality rates). Whether or not democracy is necessary, political stability is required for economic development, though it is a rarity in newly-independent former colonies. The same holds true for another requirement, sound macroeconomic policies.

Indeed, evidence shows that “sound macroeconomic… policies are associated with higher (economic) growth.” After gaining independence, many former colonies are distrustful of foreign influence. Some have tried to shield their economies from the inequitable conditions of global trade and become self-reliant by using inward-looking, noncompetitive, inefficient (more equitable), protectionist policies. Examples of these include Import Substitution Industrialization (ISI), overvalued fixed exchange rates, nationalizing enterprises and heavy government spending (and the resulting monetization of debt and inflation), import tariffs, and other, non-tariff barriers. The main goal here has usually been to achieve industrialization independently. While these policies may initially lead to rapid growth, the long-term lack of sound macroeconomic policies has caused increased disparity in developing economies, such as those in South America.

Access to new capital (hard currency) from direct and indirect capital markets is also a requirement for development. An issue LDCs face is reducing the perceived risk of investment and attracting foreign direct investment (FDI). One way of gaining capital has been to follow the International Monetary Fund (IMF) model . Another method which is slowly gaining popularity is known as microlending (or microfinance).

However, new capital can actually increase inequality if it is not allocated equitably and into appropriate production technologies (given available inputs and their costs). Inequitable access to capital also stifles “the innovation and investment that lie at the heart of modern economic growth.” While capital is necessary for growth, it is not utilized most efficiently without the existence of markets. Simply put, a private sector induces individual incentives and elicits more efficient behavior. China and India are two recent examples of the importance of markets over central planning.

According to some, population growth reduces the potential per capita growth of GNP. However, more sophisticated explanations account for labor force growth rates. As such, population growth can be seen as an investment in future growth, contributing to long-run development.

At the same time, human capital must be cultivated over time, to ensure a per worker increase in labor force productivity. In every case, human capital development has required increased educational standards, as well as the fulfillment of basic human needs.

Culture clearly affects development potential. For example, cultures with future time orientations are more likely to save, creating more reserve capital. China, a clear example of such a culture, is the biggest consumer of American reserves; essentially, it is financing America’s trade imbalance. Certain religions (such as Buddhism) tend to value diligent work and do not emphasize maximizing output efficiency. Thus, countries influenced by Buddhism may not have developed by the same means as Western nations have. Countries such as Saudi Arabia and Iran are ruled by Islamic law. To them, there is no separation of Church and State. In fact, Muslim Had crimes have a preset punishment, dictated in the Quran, while their Tazir laws (crimes against society) are punished at the discretion of a judge. Further, Sharia law claims that charging or paying interest is evil. This has significant effects on the banking industry and fund transfers. Collectivist cultures that value fairness may have less corruption and black market activity, though they may also limit competition and efficiency. Cultures with certain notions of reciprocity (such as Papua New Guinea) actually value exhibitions of grandeur and waste. Finally, heterogeneous nations increase the ease of communication, education, and governance. Certain national values, however, create inequalities from birth (such as the disempowerment of women).

Other developmental requirements that may increase intra- and inter-national inequality include urbanization and openness to trade, while developmental factors that concurrently reduce inequality include empowerment and an emphasis on justice.

Does being a LDC in today’s world help or hinder the speed and rate of economic development? On one hand, international aid is easier to receive than in the past; the world has established organizations whose purpose is to help spur economic development through structured loans. Chad and Cameroon, for example, have received about $200 million in structured loans from the World Bank, in order to prepare the necessary infrastructure to develop the Chad-Cameroon pipeline (led by ExxonMobil). On the other hand, those who seek help must undergo substantial reform programs which hinder economic growth in the short run (by reducing jobs). Also, the worse-off LDCs have many disadvantages, as they try and compete with developed nations and other more developed LDCs; this influences terms of trade and inflow of capital.

Normatively speaking, inequality is certainly not desirable in the long run; that is, it would seem just to have equitable markets. In fact, high levels of inequality make poverty reduction more difficult. Still, I believe that some degree of it is necessary in the short run, both within and between countries, especially in the modern world. Privatization, for example, leads to a loss of jobs in the short run.

What I am getting at, is that global participation is necessary. The global market affects everyone, and truly free markets do not operate equitably . In a competitive market, wages are dictated by supply and demand, not fairness. Also, because the above factors and their importance are interpreted differently by different peoples, there is no universally correct way to induce economic development.

Returning to my opening statement, all but one of these factors are directly influenced by people. While many factors are beyond the influence of individual governments, some are not. Each government largely affects its country’s pace and degree of development. It is my belief that each also has a normative (deontological) duty to adopt forward-looking policies that take into account the inevitability of global participation, the available resources and constraints, and the will of the people. Economic development in today’s LDCs cannot occur in a laissez-faire market. Proper regulation of organizations and markets should increase transparency, disprove Gresham’s Law, and improve inequality without hindering economic growth and prosperity.


* Franko, The Puzzle of Latin American Economic Development
* R. Kaplan, Was Democracy Just a Moment?, Globalization and the Challenges of a New Century
* The World Bank, Why Africa Had To Adjust
* The World Development Report

Saturday, April 11, 2009

What is Globalization and Why is it Important in Business Today?

This short writing will be barely enough to discuss either the definition of globalization or its importance to business, but I'll give it a shot. I view globalization in relation to ease of communication and interaction between people and groups worldwide. By communication and interaction I mean the flow of people (such as in the EU or use of the Visa Waiver), information (such as new technologies), ideas (such as clothing styles), philosophies (like democracy), culture (mainly Western versus all the rest), etcetera.

From one perspective, globalization means integration and increased productivity. For example, the laptop I recently bought was assembled in China using parts that were made all over the world (mostly in Asia). HP’s globalized supply chain made it possible to optimize production, thereby lowering the final cost to me, the consumer. Companies such as McDonald’s and Coca-Cola have become icons of globalization. Think of the Big Mac Index (inspired by the McDonald’s Big Mac), which uses the price of the sandwich to compare exchange rates and measure purchasing power parity in various countries.

From another perspective, globalization is akin to Western dominance and the spreading of American culture, which is, to some, desecrating the foundations of old-world traditions of other peoples (mostly non-Westerners). To some, this McDonaldization of the world means death to their own ways of life, on which many nations have based their identities. To this extent, some lash out against globalization.

Globalization used to be an opportunity for businesses; today, even for national companies, it is a requirement. In business, part of globalization is the ability to transfer (or, outsource) technologies (such as production or other business processes) to low-cost locations (off-shoring). This enables a business, and its competitors, to both target new markets and maximize cost savings.

Globalization can create many new jobs in a foreign country while eliminating “low-skilled” jobs in a company’s home country. On one hand, this causes turmoil with blue-collar employees and their families. On the other hand, one can argue that this causes future generations to seek higher education and more skilled, value-added positions. While not all agree on the ethics of globalization, all agree that it is a requisite to succeed in business (and politics) today.