EVEN under the best policy scenario, international income inequality will change only gradually. However, if policies that favor convergence are not followed, things could actually get worse.
Can the twenty-first century usher in an era of converging incomes or will it witness a continuation of past trends? Two global scenarios, developed for the World Development Report 1995, illustrate what is possible and the dangers ahead for workers in the world’s principal regions. The first scenario (muddling through) assumes that past trends persist. Because this path is likely to lead to widening differences between some regions and widening income inequality within some countries, we call it the “divergent” scenario. The second scenario—the “convergent” scenario—explores the implications of adopting strong domestic policies, combined with deeper international integration. Both scenarios assume that the technological bias favoring skilled workers that characterized the past two decades will continue. The two scenarios are only illustrative, but they are a plausible guide to the consequences of success and failure and take into account likely future trends in both economy-wide effects and international integration.
The principal determinant of the outlook for workers is domestic investment in capital, education, infrastructure, and technology. The divergent scenario assumes that recent investment trends continue or deteriorate, that a sizable share of those enrolled in school drop out, and that overall labor productivity does not rise rapidly. The convergent scenario assumes that investment rates pick up; enrollment rates stabilize at current levels and dropout rates decline; and investment in infrastructure, technological transfers, and improvements in governance raise labor productivity. The convergent scenario must be supported by at least slight rises in saving rates, lower fiscal deficits in the rich countries, and reasonable international capital flows, including development assistance. The effort in sub-Saharan Africa must be especially strong.
The international scene also matters greatly. The divergent scenario assumes that protectionism persists and that countries either drag their feet in implementing the Uruguay Round agreement or offset gains in one area with protectionism of another sort. In the convergent scenario, the Uruguay Round is fully implemented and there is further progress in trade liberalization, including in agriculture, at the regional and multilateral levels. In the divergent scenario, export growth is slow and there is little change in the international division of labor. In contrast, global integration interacts with domestic investment in capital and people to bring large net gains in the convergent scenario. The developing regions capitalize on their workers’ improved skills in an expanding global market, and all move up the technological ladder.
How does labor fare? The two scenarios result in sharp differences in growth within each region. But there are even sharper differences in labor outcomes across and within regions. The divergent scenario brings slow wage growth in most regions and rising inequality among and within regions. In contrast, the convergent scenario finds incomes rising and inequality falling across most countries and within most regions. The difference between slow and unequalizing, and high and equalizing growth stems from region-specific economic structures inherited from the past, different challenges related to comparative advantage and competition, and different sources of risk.
What do the results of the two scenarios mean for individual regions and country groupings?
Industrial economies. Workers in these economies are expected to continue to shift from producing low- and medium-skill products to high-technology goods and services. In the divergent case, the progression is slow and the demand for skills is depressed by high fiscal deficits and low exports. Increased competition by low-cost producers and biased technical change contribute to rising inequality. In the convergent case, however, internal and external conditions are more favorable, and the expansion of high-tech exports is faster. As a result, the demand for skills rises fast, and workers upgrade their skills more rapidly, raising unskilled wages and reducing inequality.
Wage inequality will decline only slowly1
Source: Figure 18.1, World Development Report 1995, Oxford University Press, New York, June 1995.
1 Actual and projected wages and employment shares by region and skill level. Wages are in 1992 international prices, scaled logarithmically. Each group’s share of the global workforce is indicated by the length of its horizontal line segment. Unlabeled line segments represent groups accounting individually for less than 2.5 percent of the global workforce (10 percent in total). The scenarios as depicted use 1992 workforce shares, not those projected for 2010. “Transitional” refers to the former centrally planned economies of Europe and Central Asia.
East Asia. The Asian newly industrialized economies are on their way to mastering the production of medium-skill products and moving to the production of high-technology goods. There are a risk of a backlash from the industrial countries that could depress this evolution, and fears of competitive pressures from the low-wage economies. Slowing the upgrading of products will result in lower wage growth for all workers. A faster transformation is likely to expose skill scarcities, resulting in a transitional period of large returns to education and increased inequality.
Transition economies. As in East Asia, the challenge for the former centrally planned economies is to upgrade the quality of their products and establish themselves as large producers of medium- and high-technology goods. But they face the additional task of developing a market economy. Botched reforms would lead to instability, low investment, and low growth. Successful reforms can start a virtuous circle with investment and growth benefiting all. In the former case, income distribution would deteriorate sharply. In the latter, there would still be some (desirable) wage decompression, but the expansion of services would help maintain the demand for unskilled workers.
Latin America. Ideally, Latin America would extend its lead in mining and agriculture and move quickly into the production of technologically intensive goods. There is a risk of greater inequality should growth remain low, as increased competition by lower-wage producers and reduced subsidies to agriculture (as agreed in the Uruguay Round) will hurt unskilled workers. With higher investment and larger gains in education, however, it may be possible to achieve a balanced growth path where all workers benefit. This will depend upon deepening the reform agenda. The enlargement of NAFTA will help anchor the policy changes, and may reduce the volatility of capital flows.
Middle East and North Africa. In some respects, the challenges for this region are similar to those of Latin America, but there is the added dimension of a difficult transition from state-led growth, and risks related to the regional security situation. With low growth, inequality would rise, resulting in low investment, capital flight, and increased international marginalization. Such an outcome would protect the labor elite to some extent, but with rising unemployment among the educated. It may be possible, however, to engineer a growth path with sharply falling inequalities, if privatization and trade reforms are successful. The challenge is to initiate a strong export push, initially in low-skill products, but with rapid upgrading so as to overtake the low-wage producers before the Uruguay Round agreements apply in full force. The possibilities of a closer association with Europe and of a peaceful resolution of old regional conflicts offer a window of opportunity.
South Asia and China. At present, the countries of this region are weakly integrated into international trade. Their increased involvement will send ripple effects throughout the world in the form of higher demand, but also increased competitive pressures on unskilled workers everywhere. There are risks related to the need to liberalize agriculture (which will hurt farmers), the possibility of large terms of trade losses in low-skill industries (hurting poor urban workers), and in China, of reforms leading to wage decompression. While these factors would result in increased inequality, there are also forces working in the opposite direction. Opportunities for balanced growth would be enhanced if the rises in food prices following the Uruguay Round are passed on to farmers, state industries are privatized, and the bias in the trade regime against rural areas is corrected. The speed of expansion of low-skill exports, an important determinant of the rate at which poverty in these countries can fall, is intrinsically related to how fast the more advanced economies upgrade their production structures and stop producing labor-intensive goods.
Sub-Saharan Africa. Africa’s plight remains the most serious challenge for the emerging new world order. A continuation of past trends—economic stagnation, self-reinforcing systemic risks, and low investment—would speed up the marginalization of the continent. If policies—domestic and international—manage to attract larger investments and increase labor productivity, growth is likely to be labor intensive and equalizing, especially if based on exports, with Africa regaining its advantages in commodities.
International inequality will change only slowly under any realistic scenario. But the scenario of convergence and inclusion could start to reduce the immense differences that now exist. The ratio between the wages of the richest and the poorest groups in the international wage hierarchy—skilled industrial country workers and African farmers—could fall from an estimated 60 to 1 in 1992 to 50 to 1 by 2010 (see chart). But, if policies that favor convergence are not followed, things could actually get worse: under the divergent scenario, the ratio of labor incomes between these two groups could rise to about 70 to 1.