Milanovic’s elephant: A tale of two worlds

Published on Tuesday, 23 August 2016

Published by Indu Bhushan on Tuesday, 23 August 2016

Street beggars in Dhaka, Bangladesh.
Street beggars in Dhaka, Bangladesh.

What is common between these recent events? The Philippines’ presidential election in May, when Filipinos overwhelmingly rejected the choice of the country’s elite; the vote for Brexit in the UK in June, with London’s clear preference to stay in the EU overruled by the country as whole; and the Donald Trump phenomenon in the US, where an unlikely candidate with no political experience and with unconventional ideas is drawing a huge following.

In all three countries, as in many other countries across the world, the vast majority feels left out of the benefits of economic growth, causing resentment against the established system which is perceived to be unfairly supporting a small number of ‘insiders’.

Inequalities are growing, in countries both in the developing and the developed world. 

That is what economist Branko Milanovic’s famous graph depicts. If you use your imagination, it looks like a happy elephant with a raised trunk. It does provide some good news – global inequality went down between 1988 and 2008, with the middle class doing very well during those two decades during which many countries adopted free markets: the Berlin Wall fell in 1988, the People’s Republic of China (PRC) opened up in the mid-1980s, and India started to liberalize its economy in 1992.

Source: Branko Milanovic, “Global Inequality: A New Approach for the Age of Globalization”

The good news, however, stops there. 

The graph also suggests that inequalities have been growing within the developing and developed world. The people at the bottom of the distribution curve  (point A in the graph)—who are largely poor people from developing countries—have not done well. The global middle class (point B)—a large proportion of whom are upper middle class people from developing countries, especially the PRC—has prospered. This implies that inequality in developing countries has increased, in some cases at unprecedented rates.

Surprisingly, those in the 80th and 90th percentiles saw their real incomes decline or stagnate during those two decades (point C). A large proportion of these people belong to the middle class in the developed world. At the same time, the global top 1% (point D) has done exceedingly well, outperforming those below. These people are mostly from developed countries, so the gap between the rich and the poor has widened in the developed world too.

What are the reasons underlying these inequalities? Milanovic suggests that there are several structural reasons, which can be categorized under three groups—Technology, Openness/globalization, and Policy, or ‘TOP’ for short. Ironically, these are precisely the factors that have driven global economic growth as well. However, these factors have disproportionately benefited those with a better education, a better capital endowment, and better political connections.

Mobility between classes has become difficult especially in the developed world. A child born into a rich and educated family stands a much better chance of growing up healthy and educated, having a family with another healthy, educated person, and getting a better-paid job than a child born into a poor and less educated family. This perpetuates inequalities.    

Globalization is where the developing and developed worlds intersect. While globalization has winners and losers in both worlds, the political debate has focused on the developed world losing jobs to the developing world. If we go back to Milanovic’s elephant, the perception is that people at point B (the middle class in the developing world) have gained at the cost of people at point C (the middle class in the developed world). And several kinds of jobs in the developed world have indeed migrated to the low-cost developing world.

This has led to a backlash against globalization and calls for protecting jobs, reviewing trade agreements, restricting immigration, reconsidering established regional ties, and even building border walls. This political debate oversimplifies the causes of increasing inequalities and overlooks the other structural reasons which might actually be more important contributory factors. 

However, blaming globalization alone for inequality is far from correct. Stemming the globalization process is not going to reduce inequalities. One, the wheels of globalization cannot be reversed. Countries can stop the inflow of migrant workers but cannot easily stop the outflow of capital to countries with lower costs. Technological advances have connected the world like never before and have made working remotely easier. This process will continue to deepen. Two, globalization has benefited a lot of people in the developing as well the developed worlds. While it might have taken jobs away from developed countries, it has also provided cheap consumer goods, increasing the buying power of all. Protectionism will produce inefficiencies and increase the prices of consumer goods, hurting low-income populations the most.   

There is no doubt that systemic inequalities are intrinsically bad, since they unjustly prevent people from achieving their potential. A person’s future should not be decided on the basis of the family into which they are born in, or the place they live or grow up in. Inequality has economic costs too. Research from the International Monetary Fund has shown that countries cannot sustain economic growth if they have a high level of inequality. Inequality also leads to social tension, which is partly reflected in the polarization of the electorate that we have seen both in developing as well as in developed countries recently.

Clearly, political leaders need to urgently focus on addressing the structural causes underpinning inequality both in developing and developed countries. These go well beyond globalization issues. This is not only the moral thing to do – it also makes for sound economics as well as prudent politics.