Globalization and Inequality in Advanced Economies: Trade, Tax Base Mobility, and Policy Implications 3031312554, 9783031312557

Table of contents :
Introduction
Contents
Acronyms
List of Figures
Chapter 1: Globalization and Inequality: The Facts
1.1 Trade, Offshoring, FDI and Inequality
1.1.1 Changes in Trade Structure
1.1.2 FDI and Multinationalization of Firms
1.1.3 Patterns of Rising Inequality
1.2 Migration, Mobility of Tax Bases and Decrease in Tax Progressivity
1.2.1 Decrease in Mobility Costs
1.2.2 Immigration
1.2.3 Changes in the Tax Structures
1.3 Public Social Expenditure and Public Debt
1.3.1 General Increase in Public Social Expenditures
1.3.2 Changes in Redistribution
1.3.3 Increase in Public Debts
1.4 Unemployment, Skill Endowment and Labour Market Rigidity
1.4.1 Unemployment
1.4.2 Skill Endowment
1.4.3 Labour Cost and Labour Market Rigidities
1.4.3.1 Difference in Labour Costs Between Advanced and Emerging Countries
1.4.3.2 Labour Market Institutions
1.5 Major Stylized Facts
Chapter 2: Trade and Inequality
2.1 Comparative Advantage, North-South Trade and Inequality
2.1.1 The North-South Heckscher-Ohlin Approach and its Shortcomings
2.1.1.1 The Basic NS-HOS Model and Inequality
2.1.1.2 Unconfirmed Predictions
2.1.2 Divergence in Factor Endowments, Non-equalization in Factor Price and Stages of Globalization
2.1.3 Differences in Productivity and Technology
2.1.4 Labour Market Failures and Unemployment
2.1.4.1 Institutional Constraint and the Inequality-Unemployment Trade-Off
2.1.4.2 Impact of a Minimum Wage and Extension to Downward-Rigid Wages
2.1.4.3 North-South Trade, Efficiency Wage and Unemployment
2.1.5 A Large Number of Countries and Sectors
2.1.6 Capital and Capital Mobility
2.2 Offshoring and Global Value Chains
2.2.1 Offshoring in Intermediate Goods
2.2.2 Offshoring in Individual Tasks
2.3 Trade and Technology Interplay
2.3.1 Capital-Skill Complementarity
2.3.2 Property Rights Enforcement and Globalization-Driven-Biased Technical Change
2.4 Polarization
2.4.1 Skill Upgrading in Emerging Countries and Polarization
2.4.2 Globalization-Induced Education Decisions and Polarization
2.4.3 Empirical Evidence
2.5 Globalization and the Superstars
2.6 Empirical Evidence on Trade and Inequality
2.7 Major Lessons on Trade and Inequality
Appendices
Appendix A: The Basic North-South HOS Model
Autarky
North-South Openness
The Integrated Global Economy
The Diversification Cone
Appendix B: The NS-HOS Model with Fair Wage
North and South Produce Both Goods
North Produces Both Goods and South Good l Only
North Produces Good h Only
Appendix C: The NS-HOS Model with Offshoring
Appendix D: A Basic Model with Offshoring in Tasks
Unskilled Tasks Are Produced in Both Areas
The North Skill Premium
Prices
Real Wages
The Real Income per Head
Unskilled Tasks Are only Produced in the South
Labour Market Imperfections
Chapter 3: Factor Mobility, Tax Base Mobility and Tax Competition
3.1 Mobility of Tax Bases, Tax Competition and Race to the Bottom
3.1.1 Mobility of Tax Bases and Globalization
3.1.2 Tax Competition and Race to the Bottom
3.2 Corporate Tax Competition
3.2.1 Theoretical Approaches
3.2.2 Empirical Evidence
3.3 Income Tax Competition
3.3.1 Theoretical Approaches
3.3.2 Empirical Evidence
3.4 Tax Evasion
3.4.1 Tax Evasion: Basic Mechanisms
3.4.2 Tax Evasion: Weight and Impact
3.5 Major Lessons on Tax Base Mobility, Tax Competition and Tax Evasion
Appendix: Mobility of Tax Bases and Race to the Bottom
Source-Based Taxation
Resident-Based Taxation
Chapter 4: Anti-inequality Policies and Globalization
4.1 Labour Market Institutions and the Inequality-Unemployment Trade-Off
4.1.1 The Inequality-Unemployment Trade-Off
4.1.2 Globalization and Unionization
4.2 Progressivity-Redistribution Trade-Off, Middle-Class Curse and Social Democracy Curse
4.2.1 Middle-Class Curse and the Progressivity-Redistribution Trade-Off
4.2.2 Social Democracy Curse and the Rise of Populism
4.3 Public Deficit and Debt
4.4 Globalization, Education and Inequality
4.4.1 The `Incentive Effect´
4.4.2 The `Cost of Education´ Effect
4.4.3 Total Effect and Policy Implications
4.5 Major Lessons on Globalization and Anti-inequality Policies
Appendices
Appendix A: The Monopoly Union Model
Appendix B: The Efficient Bargaining Model
Bargaining Without Globalization
Bargaining with Globalization
Appendix C: Impact of Globalization on Education
Chapter 5: Further Researches and Policy Implications
5.1 General Diagnosis and Implications for Researches
5.1.1 General Diagnosis
5.1.2 Implication for Researches on the Globalization-Inequality Relationship
5.1.2.1 Trade and FDI
5.1.2.2 Other Components of Globalization
5.1.2.3 Synthetic Indicators of Globalization and Meta-analyses
5.1.2.4 Changing Policies and Institutions and Alternatives to Inequality
5.2 New Fields of Research
5.2.1 Posted Workers
5.2.2 Global Value Chains and Increasing Economic Risks
5.2.3 Education and the Emergence of a Globalized Elite
5.3 Globalization-Consistent Public Policies
5.3.1 Conditional Provision of Public Services and Social Advantages
5.3.2 Globalization-Consistent Taxation
Conclusion
References
Author Index
Subject Index

Citation preview

Economic Studies in Inequality, Social Exclusion and Well-Being Series Editor: Jacques Silber

Joël Hellier

Globalization and Inequality in Advanced Economies Trade, Tax Base Mobility, and Policy Implications

Economic Studies in Inequality, Social Exclusion and Well-Being Series Editor Jacques Silber, Ramat Gan, Israel

Traditionally, economists have identified well-being with market command over goods rather than with the “state” of a person. The books in this series go precisely beyond the traditional concepts of consumption, income or wealth and offer a broad, inclusive view of inequality and well-being. Topics include, but are not limited to: Capabilities and Inequalities, Discrimination and Segregation in the Labour Market, Equality of Opportunities, Globalization and Inequality, Human Development and the Quality of Life, Income and Social Mobility, Inequality and Development, Inequality and Happiness, Inequality and Malnutrition, Income and Social Mobility, Inequality in Consumption and Time Use, Inequalities in Health and Education, Multidimensional Inequality and Poverty Measurement, Polarization, Poverty among Children and Elderly People, Social Policy and the Welfare State, and Wealth Distribution.

Joël Hellier

Globalization and Inequality in Advanced Economies Trade, Tax Base Mobility, and Policy Implications

Joël Hellier Economics University of Nantes and LEM-CNRS (UMR 9221) Lille, France

ISSN 2364-107X ISSN 2364-1088 (electronic) Economic Studies in Inequality, Social Exclusion and Well-Being ISBN 978-3-031-31255-7 ISBN 978-3-031-31256-4 (eBook) https://doi.org/10.1007/978-3-031-31256-4 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Introduction

The purpose of this volume is to make an assessment of the impact of globalization on rising inequality in advanced economies. We present a general diagnosis based on the economic literature exposed in five chapters. This diagnosis is provisional since both globalization and inequality are by nature evolutionary processes. Since the early 1990s, the world economy has known a new wave of globalization which displays several key characteristics. First, the weight of emerging countries, especially China, in the world production and trade of manufacturing has critically increased. Second, the offshoring of both intermediate goods and tasks has become a prominent feature of international trade, leading to an international segmentation of production processes (global value chains) in which emerging countries play a key role. Third, the international mobility of productive and financial capital, of firms, of high skilled and talented workers and of tax bases has significantly risen, both across advanced countries and between advanced and emerging countries. Concurrently, following a post-World War II period of decrease, income and wealth inequality has known an upsurge in all advanced economies, even if the countries differ in the timing and the intensity of this reversal. Anglo-Saxon countries, particularly the USA, display the earliest and the highest increase in inequality. Nordic countries have also experienced an important rise, but they were initially highly egalitarian and they therefore remain less inequality-oriented than other advanced economies. In contrast, the increase in inequality has been rather modest in South Europe, but their inequality remains high because it was initially elevated. Finally, Continental Europe (Austria, Belgium, France, Germany)1 and Japan have displayed both a moderate increase and a moderate level of inequality. The concomitance of the new wave of globalization and of the upsurge in withinadvanced countries inequality has motivated a large economic literature which has attempted to understand and measure the impact of the former on the latter. There were in fact three natural candidates to explain growing inequality, namely, technical

1

The Netherlands stands between Nordic countries and Continental Europe. v

vi

Introduction

change, globalization and institutions. Skill-biased technical change explains rising inequality by making production more skill-intensive. Changes in institutions foster inequality by curbing minimum wages and reducing redistribution and social protection. As regards globalization, its three components (new competition from emerging countries, offshoring and increasing mobility of factors and tax bases) participate in the increase in inequality. In addition, technical change, globalization and institutions are not independent of each other and their interactions can nurture inequality. The general diagnosis resulting from the five chapters in this volume is the following: 1. Trade with emerging countries (North-South trade, henceforth NST) and offshoring has widened inequality between low- and middle-skilled workers on the one hand and high-skilled workers and capital owners on the other hand, generating thereby winners and losers. But trade would have increased the average income per capita provided that wage adjustment had maintained full employment. Consequently, a way to make NST and offshoring beneficial for everyone (‘Pareto-optimal’) is to transfer a part of the winners’ gains to the losers, i.e. redistribution. 2. The growing mobility of factors, firms and tax bases has generated tax competition, entailing a decrease in the taxes paid by the highest incomes and the wealthiest households. This not only prevents the redistribution of the gains of trade from the winners to the losers, but it also enriches even more the winners by reducing their tax burden. 3. Globalization significantly modifies the outcomes, efficiency and feasibility of a number of social policies, tax policies and budget policies. It tends to create a trade-off between inequality and unemployment and a trade-off between redistribution and tax progressivity, generating an opposition between the low paid and the middle class as regards redistribution. This jeopardizes the political position of the social democracy and fosters the rise of populism. It can also weaken intergenerational mobility and skill upgrading which is a way to reduce inequality in the longer term. 4. Reshaping social and tax policies is thus necessary to make them consistent with the constraints linked to globalization. A first possible way could be to shorten the free access to certain public services (health, education, public equipment, etc.) for the firms and households who are not taxpayers in the country, making them pay to benefit from those services. This would typically raise the mobility cost of tax bases. Another way consists in changing the calculation of tax bases to make them become non-mobile. As regards corporate tax, the move from a sourcebased to a destination-based taxation could permit such a change. In a nutshell: trade is not the main ‘culprit’ for the globalization-induced increase in inequality, firm and tax base mobility and the related tax and social competition being the first to blame because they impede the redistribution of the gains of trade from the winners to the losers. Inventing new means and tools permitting to counteract tax and social competition thus constitutes a major challenge for antiinequality policies.

Introduction

vii

The book primarily focuses on the economic mechanisms which bind growing inequality to the different aspects of globalization. The results of the empirical literature which attempts to assess the strength of those mechanisms are presented. However, the number of subjects and the related works are so vast that we do not provide comprehensive reviews of the empirical literatures for which we often refer to existing surveys. In the body of the text, mathematical presentations are severely limited so that non-experts in economics can read most of the developments. Short and stylized mathematical models presenting simple demonstrations of the main results of the literature are placed in appendices at the end of each chapter. Chapter 1 exposes the key stylized facts which underlie the analyses presented in this book. We insist on indicators (i) of the different components of globalization, (ii) of the different forms of inequality and their possible counterparts and (iii) on the observed changes in social policies, labour market institutions and tax and budget policies. Chapter 2 tackles the large issue of the impact of trade on inequality in advanced economies. It focuses on the two major changes in the trade structure which characterize the present wave of globalization, i.e. North-South trade and offshoring. In consequence, two major approaches which can explain the impact of trade on inequality are primarily discussed, i.e. the North-South Heckscher-Ohlinian model and its extensions and the offshoring in task model. We also analyse the interplay between globalization and technical change, the impact of globalization on the highest incomes (top 1%, top 0.1%,) and the ‘superstars’(top 0.01%) and the more recent ‘polarization’ process which hurts the middle-class incomes and jobs. Chapter 3 is devoted to the impact of the growing mobility of factors, firms and tax bases. Here, globalization takes the form of a constant decrease in mobility costs at the international level. We insist on the mechanisms of tax competition and the related tax cuts on high incomes and capital returns. Chapter 4 analyses the effects of globalization on anti-inequality public policies. It shows (i) how globalization constrains the governments’ action by generating an inequality – unemployment trade-off and a tax progressivity – redistribution tradeoff, (ii) how this leads to a ‘middle-class curse’ and (iii) how it jeopardizes social democracy and fosters populism. Chapter 5 finally examines some implications and extensions of the analyses developed in the preceding chapters. We firstly present a stylized diagram encompassing the different mechanisms of the globalization-inequality nexus in advanced economies, and we highlight their implications on the researches and estimates of this impact. We secondly present several new fields of research which could be investigated to enlarge the analyses on the subject. We finally indicate several ways and lines of research to make anti-inequality policies consistent with globalization.

Contents

1

2

Globalization and Inequality: The Facts . . . . . . . . . . . . . . . . . . . . . . 1.1 Trade, Offshoring, FDI and Inequality . . . . . . . . . . . . . . . . . . . . . 1.1.1 Changes in Trade Structure . . . . . . . . . . . . . . . . . . . . . . . 1.1.2 FDI and Multinationalization of Firms . . . . . . . . . . . . . . . 1.1.3 Patterns of Rising Inequality . . . . . . . . . . . . . . . . . . . . . . . 1.2 Migration, Mobility of Tax Bases and Decrease in Tax Progressivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.1 Decrease in Mobility Costs . . . . . . . . . . . . . . . . . . . . . . . . 1.2.2 Immigration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.3 Changes in the Tax Structures . . . . . . . . . . . . . . . . . . . . . 1.3 Public Social Expenditure and Public Debt . . . . . . . . . . . . . . . . . . 1.3.1 General Increase in Public Social Expenditures . . . . . . . . . 1.3.2 Changes in Redistribution . . . . . . . . . . . . . . . . . . . . . . . . 1.3.3 Increase in Public Debts . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 Unemployment, Skill Endowment and Labour Market Rigidity . . . 1.4.1 Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4.2 Skill Endowment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4.3 Labour Cost and Labour Market Rigidities . . . . . . . . . . . . 1.5 Major Stylized Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trade and Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Comparative Advantage, North-South Trade and Inequality . . . . . . 2.1.1 The North-South Heckscher-Ohlin Approach and its Shortcomings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1.2 Divergence in Factor Endowments, Non-equalization in Factor Price and Stages of Globalization . . . . . . . . . . . . 2.1.3 Differences in Productivity and Technology . . . . . . . . . . . 2.1.4 Labour Market Failures and Unemployment . . . . . . . . . . . 2.1.5 A Large Number of Countries and Sectors . . . . . . . . . . . . . 2.1.6 Capital and Capital Mobility . . . . . . . . . . . . . . . . . . . . . . .

1 2 2 5 5 11 11 12 13 16 16 17 17 18 18 20 23 27 29 30 30 33 37 38 44 47 ix

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2.2

3

Offshoring and Global Value Chains . . . . . . . . . . . . . . . . . . . . . . 2.2.1 Offshoring in Intermediate Goods . . . . . . . . . . . . . . . . . . . 2.2.2 Offshoring in Individual Tasks . . . . . . . . . . . . . . . . . . . . . 2.3 Trade and Technology Interplay . . . . . . . . . . . . . . . . . . . . . . . . . 2.3.1 Capital-Skill Complementarity . . . . . . . . . . . . . . . . . . . . . 2.3.2 Property Rights Enforcement and GlobalizationDriven-Biased Technical Change . . . . . . . . . . . . . . . . . . . 2.4 Polarization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4.1 Skill Upgrading in Emerging Countries and Polarization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4.2 Globalization-Induced Education Decisions and Polarization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4.3 Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5 Globalization and the Superstars . . . . . . . . . . . . . . . . . . . . . . . . . 2.6 Empirical Evidence on Trade and Inequality . . . . . . . . . . . . . . . . . 2.7 Major Lessons on Trade and Inequality . . . . . . . . . . . . . . . . . . . . Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix A: The Basic North-South HOS Model . . . . . . . . . . . . . Appendix B: The NS-HOS Model with Fair Wage . . . . . . . . . . . . Appendix C: The NS-HOS Model with Offshoring . . . . . . . . . . . . Appendix D: A Basic Model with Offshoring in Tasks . . . . . . . . .

48 49 49 52 52

Factor Mobility, Tax Base Mobility and Tax Competition . . . . . . . . 3.1 Mobility of Tax Bases, Tax Competition and Race to the Bottom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.1 Mobility of Tax Bases and Globalization . . . . . . . . . . . . . . 3.1.2 Tax Competition and Race to the Bottom . . . . . . . . . . . . . 3.2 Corporate Tax Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.1 Theoretical Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.2 Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Income Tax Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Theoretical Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.2 Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Tax Evasion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.1 Tax Evasion: Basic Mechanisms . . . . . . . . . . . . . . . . . . . . 3.4.2 Tax Evasion: Weight and Impact . . . . . . . . . . . . . . . . . . . 3.5 Major Lessons on Tax Base Mobility, Tax Competition and Tax Evasion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix: Mobility of Tax Bases and Race to the Bottom . . . . . . . . . . . Source-Based Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Resident-Based Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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53 54 56 56 57 58 59 60 61 61 65 67 68

74 74 75 77 77 78 80 81 83 83 84 85 86 87 88 89

Contents

4

5

Anti-inequality Policies and Globalization . . . . . . . . . . . . . . . . . . . . . 4.1 Labour Market Institutions and the Inequality-Unemployment Trade-Off . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1.1 The Inequality-Unemployment Trade-Off . . . . . . . . . . . . . 4.1.2 Globalization and Unionization . . . . . . . . . . . . . . . . . . . . . 4.2 Progressivity-Redistribution Trade-Off, Middle-Class Curse and Social Democracy Curse . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.1 Middle-Class Curse and the Progressivity-Redistribution Trade-Off . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.2 Social Democracy Curse and the Rise of Populism . . . . . . 4.3 Public Deficit and Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Globalization, Education and Inequality . . . . . . . . . . . . . . . . . . . . 4.4.1 The ‘Incentive Effect’ . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4.2 The ‘Cost of Education’ Effect . . . . . . . . . . . . . . . . . . . . . 4.4.3 Total Effect and Policy Implications . . . . . . . . . . . . . . . . . 4.5 Major Lessons on Globalization and Anti-inequality Policies . . . . . Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix A: The Monopoly Union Model . . . . . . . . . . . . . . . . . . Appendix B: The Efficient Bargaining Model . . . . . . . . . . . . . . . . Appendix C: Impact of Globalization on Education . . . . . . . . . . . . Further Researches and Policy Implications . . . . . . . . . . . . . . . . . . . 5.1 General Diagnosis and Implications for Researches . . . . . . . . . . . . 5.1.1 General Diagnosis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1.2 Implication for Researches on the Globalization-Inequality Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2 New Fields of Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.1 Posted Workers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.2 Global Value Chains and Increasing Economic Risks . . . . . 5.2.3 Education and the Emergence of a Globalized Elite . . . . . . 5.3 Globalization-Consistent Public Policies . . . . . . . . . . . . . . . . . . . . 5.3.1 Conditional Provision of Public Services and Social Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3.2 Globalization-Consistent Taxation . . . . . . . . . . . . . . . . . .

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91 92 92 94 99 99 100 102 102 103 104 104 106 107 107 108 113 117 118 118 120 124 125 126 127 128 128 129

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 Author Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

Acronyms

CTC CTR DTC FDI GDP HOS (model, approach) ICT ITC IUT MNE, MNF NS-HOS model NST SBTC TBTC TFP VAT WW2

Corporate Tax Competition Corporate Tax Rate Directed Technological Change Foreign Direct Investment Gross Domestic Product Heckscher-Ohlin-Samuelson Information and Communication Technology Income Tax Competition Inequality-Unemployment Tradeoff Multinational Enterprise, Firm North-South Heckscher-Ohlin-Samuelson Model North-South Trade Skill-Biased Technical Change Task-Biased Technical Change Total Factor Productivity Value Added Tax World War II

xiii

List of Figures

Fig. 1.1 Fig. 1.2 Fig. 1.3 Fig 1.4 Fig. 1.5 Fig. 1.6 Fig. 1.7 Fig. 1.8 Fig. 1.9 Fig. 1.10

Fig. 1.11 Fig. 1.12 Fig. 1.13 Fig. 1.14 Fig. 1.15 Fig. 1.16 Fig. 1.17 Fig. 1.18 Fig. 1.19 Fig. 1.20 Fig. 1.21

Weight of each area in the world exports of manufacturing (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weight (%) of China in the exports of manufacturing to the world and developed countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weight of advanced economies in the world exports of manufacturing (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Advanced countries’ imports of manufacturing (% of GDP, 1967 = 100) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intermediate goods from the South in the North imports of manufacturing (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FDI/GDP at the world level: outward flows (‰) and stocks (%) Share of emerging countries in the world inflows of FDI . . . . . . Pre-redistribution earnings inequality (Gini market) . . . . . . . . . . . . Post-redistribution earnings inequality (Gini disposable) . . . . . . . Variation (%) in income shares by income groups*, 1980–2019. (a) Pre-tax income share, (b) Post-tax income share . . .. . .. . . .. . .. . . .. . .. . . .. . .. . . .. . .. . . .. . .. . . .. . .. . . .. . . .. . .. . . .. . Variation (%) in pre-tax income shares by income groups,* 2000–2019 . .. . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . Pre-tax top income shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . KOF index of social globalization, advanced countries . . . . . . . . Net immigration rate*, 1960–2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Average statutory corporate tax rate. (a) 1980–2005 . . . . . . . . . . . Advanced countries: top marginal income tax rates, 1980–2012 . .. . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . . . .. . . Income tax and social contribution rate . . . . . . . . . . . . . . . . . . . . . . . . . . OECD unweighted average VAT rate . . . .. . . .. . . . .. . . .. . . . .. . . .. . Social public expenditure (% GDP). (a) Total, (b) Except unemployment and old age .. . . . . .. . . . . .. . . . . .. . . . . .. . Relative redistribution rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General public debt in % of GDP, 1990–2015 . . . . . . . . . . . . . . . . . .

3 3 4 4 5 6 6 8 8

9 9 10 12 13 14 14 15 15 16 17 18 xv

xvi

Fig. 1.22 Fig. 1.23 Fig. 1.24 Fig. 1.25 Fig. 1.26 Fig. 1.27 Fig. 1.28 Fig. 1.29 Fig. 1.30 Fig. 1.31 Fig. 1.32 Fig. 2.1 Fig. 2.2 Fig. 2.3

List of Figures

Rates of unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rate of unemployment by skill level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Low skilled in the population (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . High skilled in the population (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Middle skilled in the population (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Post-secondary education attainment, 25–64 years old, both genders, ratio area/China (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Enrolment in tertiary ed. per generation ratio advanced countries/China (%), 1980–2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . GDP per capita in emerging countries Ratio GDP per capita in developed countries (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . wage RatioMinimum Mean wage . . . .. . . . .. . . .. . . . .. . . . .. . . .. . . . .. . . .. . . . .. . . .. . . . .. . Strictness of employment protection, 1990–2019. (a) Temporary contract, (b) Dismissals . . . . . . . . . . . . . . . . . . . . . . . . . . Union density, 1980–2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

19 19 20 21 22 22 23 24 25 25 26

Fig. 2.4

The diversification cone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . South outside the diversification cone . . . .. . . .. . . . .. . . .. . . . .. . . .. . Adjustment with an institutional constraint on the skill premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Several countries with different skill endowments . . . . . . . . . . . . . .

34 35

Schema 5.1 Fig. 5.1 Schema 5.2

Determinants of the globalization-inequality nexus . . . . . . . . . . . . . 119 Indicators of globalization . . . .. . .. . . .. . .. . . .. . .. . . .. . .. . . .. . .. . . .. . 123 Institutional determinants and alternatives to inequality * . .. . . . 124

39 46

Chapter 1

Globalization and Inequality: The Facts

This chapter exposes some key empirical facts which underlie the analyses and diagnoses presented in this book. Each fact is illustrated by figures and its major characteristics are highlighted. Four strands of facts are emphasized. The developments of trade, offshoring, FDI and their concomitance with the dynamics of inequality are firstly examined (Sect. 1.1). The modifications affecting the taxation structures and their determinants are subsequently exposed (Sect. 1.2). The changes in the international mobility of tax bases and the weight of each tax in the total levies are particularly pointed out. Section 1.3 is devoted to the variations in public social expenditures and redistribution and to the way they are financed. Section 1.4 is centred on the changes in certain key characteristics of the labour markets in advanced countries, i.e. market rigidities, skill levels of the working population and unemployment. The major stylized facts drawn by those four strands of development are highlighted in Sect. 1.5. The selected data end in 2018/2019 so as to erase the impacts of the COVID pandemic and the Ukraine war. When it makes sense, we put together the countries which have similar developments. This leads to the definition of six groups of countries: Continental Europe (Austria, Belgium, France, Germany, the Netherlands), Nordic countries (Denmark, Finland, Norway, Sweden), South Europe (Greece, Italy, Portugal, Spain), non-US Anglo-Saxon countries (Australia, Canada, New Zealand, the UK), the USA and Japan remaining apart because they display specific developments. Those groups are not utilized for the variables for which the countries have different behaviours. Finally, Korea and Taiwan have not been inserted in the set of advanced economies. If they now indubitably belong to this category, it was not the case in the 1980s when they were rather considered as emerging economies (‘Newly Industrialized Countries’).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4_1

1

2

1.1

1

Globalization and Inequality: The Facts

Trade, Offshoring, FDI and Inequality

This first section highlights the changes in trade, FDI and inequality over the last four decades. In the post-World War II (WW2) period, international trade had known a significant increase, but this development essentially concerned advanced economies (the USA, Western Europe and Japan). The structure of international trade was then characterized by trade in manufacturing between developed countries, developing countries being principally providers of raw materials (energy, metals, minerals, agricultural primary goods, etc.). From the late 1960s, a first wave of developing countries began to specialize in standardized and low-skill intensive industries (the ‘Newly Industrialized Countries’, Korea, Taiwan, Hong Kong and Singapore), followed by some Southeast Asian countries (Malaysia, Thailand). Altogether, those countries were nevertheless narrow in size, and their impact upon labour demand and employment in advanced economies remained limited. The advent of China and the international outsourcing of production stages and tasks have completely modified this picture. The 1960s have known a development of FDI by multinational firms (MNF), particularly US MNF. However, FDI flows essentially took place between advanced economies and were motivated by the conquest of new markets. From the early 1990s, intra-firm offshoring based on production costs and the related investments to emerging countries have become a major motive for FDI.

1.1.1

Changes in Trade Structure

Since the early 1990s, world trade has grown more rapidly than world production, but we have already stressed that this development is not really new and has been observed in the 1960s and 1970s. The key changes concern the structure of trade. First, the weight of emerging countries in the world exports of manufacturing which had remained broadly unchanged from the 1960s to the mid-1980s has substantially risen (Fig. 1.1), from about 10% in 1985 to 43% at the eve of the COVID pandemic. The rise in the weight of emerging countries is to a large extent attributable to China (Fig. 1.2). Symmetrically, the weight of advanced economies has significantly shrunk (Fig. 1.3). The advanced countries’ imports of manufacturing from emerging countries have critically increased since the early 1990s, whereas the between-advanced countries’ imports of manufacturing (in percent of GDP) have slightly decreased in the last 20 years (Fig. 1.4). Second, the trade of intermediate goods and the between-country division of stages and tasks for the production of commodities have grown more rapidly than total trade, and the share of intermediate goods from emerging countries in the North imports of manufacturing has substantially risen since the early 1990s (Fig. 1.5). Hence, the growing position of the South in the production of manufacturing does

1.1

Trade, Offshoring, FDI and Inequality

3

Fig. 1.1 Weight of each area in the world exports of manufacturing (%) Source: CEPII, CHELEM database. https://db.nomics.world/CEPII

Fig. 1.2 Weight (%) of China in the exports of manufacturing to the world and developed countries Source: CEPII, CHELEM database. https://db.nomics.world/CEPII

4

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Globalization and Inequality: The Facts

Fig. 1.3 Weight of advanced economies in the world exports of manufacturing (%) Source: CEPII, CHELEM database

Fig 1.4 Advanced countries’ imports of manufacturing (% of GDP, 1967 = 100) Source: CEPII, CHELEM database

1.1

Trade, Offshoring, FDI and Inequality

5

Fig. 1.5 Intermediate goods from the South in the North imports of manufacturing (%) Source: CEPII, CHELEM database

not only concern sectoral specialization (textile, clothing, standardized consumer goods, etc.), but it also and somewhat primarily involves production stages and tasks. Within such a pattern, the unskilled stages and tasks in the production of hightech and high-skilled industries (electronic, computers, etc.) are relocated to emerging countries.

1.1.2

FDI and Multinationalization of Firms

On top of trade, foreign direct investments have considerably increased at the world level (Fig. 1.6). This increase began in the mid-1980s and accelerated in the 1990s. Since 2000, the ratio of FDI flows to GDP has fluctuated between 2% and 2.5%, i.e. at a rather high level, and the stock of foreign capital in GDP has continued to grow rapidly (Fig. 1.6). This upsurge in FDI is to a large extent the result of the investments of northern multinationals in emerging economies (Fig. 1.7). This has not only brought capital to those countries. It has also permitted large technological transfers from the North to the South since the multinationals’ affiliates produce with their own technologies.

1.1.3

Patterns of Rising Inequality

During the 30 years following World War II (WW2), advanced economies were characterized by a general reduction in inequality. Since then, all advanced countries

6

1

Globalization and Inequality: The Facts

Fig. 1.6 FDI/GDP at the world level: outward flows (‰) and stocks (%) Source: CEPII, CHELEM database

Fig. 1.7 Share of emerging countries in the world inflows of FDI Source: UNCTAD

have experienced an increase in income and earnings inequality, even if the turnabout and the intensity significantly differ across countries. There are several ways to measure inequality. In this presentation, we focus on two types of indicators which are both relevant and complementary when considering the globalization-inequality nexus. The first is the Gini coefficient which can be

1.1

Trade, Offshoring, FDI and Inequality

7

interpreted as the distance from perfect equality. The second set of measures is centred on the income share of certain income groups (bottom 30%, interval between percentile 30 and percentile 70, interval between percentile 70 and percentile 10, top 10%, top 1% , top 0.1%). This second type of indicator permits to identify the shape of changes in inequality, i.e. the weights of moves in the bottom, the middle and the top of the income spectrum in those changes. We make a usual distinction between pre-tax and redistribution income and post-tax and redistribution income. The former portrays the impact on income of market forces (supply and demand) and balance of power between income earners (e.g. in bargaining processes). The second takes into account the impact of public levies and transfers on incomes, i.e. the income effectively received by individuals and households. Figures 1.8 and 1.9 clearly show that both the pre-tax and the post-tax and redistribution earnings inequality have substantially increased since 1980 in all developed areas. In all areas, the post-redistribution Gini is significantly lower than the pre-redistribution value, which indicates that redistribution is effective everywhere. There is however a clear difference in variation between the two indicators. The pre-redistribution earnings inequality have similar profiles in our five areas (the USA, non-US Anglo-Saxon countries, South Europe, Continental Europe, Nordic countries), and the between-area deviations remain limited. In contrast, the between-area deviations are large both in level and variation for the post-tax and redistribution inequality. This typically highlights large differences in redistribution across advanced economies, and it is particularly clear when comparing the USA and Continental Europe. The difference in Gini market (pre-redistribution) between the two areas is of 0.9 points in 1980 (42.9 in the USA against 42.1 in Continental Europe) and of 1.6 Gini points in 2015 (50.9 against 49.3). For the Gini disposable (post-redistribution), the difference is of 5.7 in 1980 (31.6 against 25.9) and of 9.9 in 2015 (37.7 against 27.8). Such a huge divergence between the two areas denotes clear differences in their redistribution policies. It can be noticed that (i) the USA exhibits a specific development with a much higher increase in inequality than all other advanced countries and (ii) the betweencountry deviation in the post-redistribution inequality has increased since 1980. Figure 1.10 depicts the variation in the income shares of five income groups over the 1980–2019 period: (1) the low paid, representing the bottom 30 percentiles; (2) the middle class, located between percentile p.30 and p. 70; (3) the upper middle class (p70–p90); (4) the high incomes (p.90–p.99); and (5) the ‘rich’ (p.99–p100). We distinguish the before-tax income share (Fig. 1.10a) and the after-tax income share (Fig. 1.10b). In all areas except France, a higher-income group corresponds to a higher increase or lower decrease in the income share, and this is true for both pre-tax and post-tax shares. Considering pre-tax income shares in the period 2000–2019 (Fig. 1.11), the between-area difference is more pronounced. The USA and the UK (and to a lesser

8

1

Globalization and Inequality: The Facts

Fig. 1.8 Pre-redistribution earnings inequality (Gini market) Source: WIID (Solt database), 2016. Notes: Non-weighted average. Continental Europe: Austria, Belgium, France, Germany, Netherlands. Non-US Anglo-Saxon: Australia, Canada, Ireland, New Zealand, UK. Nordic countries: Denmark, Finland, Norway, Sweden. South Europe: Greece, Italy, Portugal, Spain

Fig. 1.9 Post-redistribution earnings inequality (Gini disposable) Source: WIID (Solt database), 2016. Notes: Non-weighted average. Countries in each group: see Fig. 1.8

1.1

Trade, Offshoring, FDI and Inequality

9

Fig. 1.10 Variation (%) in income shares by income groups*, 1980–2019. (a) Pre-tax income share, (b) Post-tax income share in 2019 - Income share in 1980 Source: WID. * Income shareIncome × 100 ; income groups: low paid = percentile share in 1980 (p) 0–p30; middle class = p30–p70; upper middle class = p70–p90; high incomes = p90–p99; rich = p99–p100. Japan is not considered because the WID data are not available for this country

Fig. 1.11 Variation (%) in pre-tax income shares by income groups,* 2000–2019 in 2019 - Income share in 1980 Source: WID. * Income shareIncome × 100; Income groups: Low paid = percentile share in 1980 (p) 0–p30; Middle Class = p30–p70; Upper Middle Class = p70–p90; High incomes = p90–p99; Rich = p99–p100. Japan is not considered because the WID data are not available for this country)

10

1

Globalization and Inequality: The Facts

Fig. 1.12 Pre-tax top income shares Source: WID. Continental Europe: Austria, Belgium, France, Germany, the Netherlands. South Europe: Greece, Italy, Portugal, Spain. Non-US Anglo Saxon countries: Australia, Canada, New Zealand, the UK. Nordic countries: Denmark, Finland, Norway, Sweden

extent South Europe) exhibit ‘polarized’ profiles where the low paid display an income advantage compared to the middle class or the upper middle class. It must be noted that based on different data (particularly wages and occupations), a number of studies diagnosed that polarization in incomes and in employment concerns a majority of advanced countries since the mid-1990s (Goos & Manning, 2007, for the UK; Autor et al., 2003, 2006, and Oldenski, 2014, for the USA; Falvey et al., 2010, for Portugal; Goos et al., 2014, for 16 Western European countries; Harrigan, 2016, for France). In summary, over the 1980–2019 period, all countries and areas except France display rather similar variations. Those variations are the following: 1. High incomes (top 10% and top 1%) benefit from an increase in both pre- and post-tax income shares, whereas other income groups exhibit losses. The increase is particularly high for the rich (top 1%), and it is even higher for the superrich (top 0.1%), as shown in Fig. 1.12. 2. As regards the pre-tax income share, the higher the income, the higher the gain, i.e. inequality increases throughout the income spectrum, and tax and redistribution do not modify this hierarchy (Fig. 1.10); it only reduces the losses of the low paid and the middle class. 3. In all countries, the middle class loses (in share), even if this loss is lower than that of the low paid. 4. The increase in the share of the rich (top 1%) is higher for the post-tax income than for the pre-tax income in the USA, the UK and Germany. This shows that for the very top of the income ladder, the variation in the tax scheme since 1980 has magnified their gains. As regards income, a last stylized fact deserves to be mentioned. The labour share of total income has significantly decreased in all advanced economies, and the

1.2

Migration, Mobility of Tax Bases and Decrease in Tax Progressivity

11

capital share has increased, since the early 1980s. We do not show here the related figures, and we refer to European communities (2007, Chapter 5, Chart 4) and Autor et al. (2020b, Fig. 1 p. 647). Here again, the decline is particularly pronounced in the USA.

1.2 1.2.1

Migration, Mobility of Tax Bases and Decrease in Tax Progressivity Decrease in Mobility Costs

The increasing mobility of physical and financial capital is now generally recognized and well documented. It essentially results from (i) institutional changes which occurred in the 1980s and 1990s and have liberalized both FDI flows and financial capital mobility and (ii) technological changes (reduction in transportation and communication costs, new financial tools, global banking system, etc.). Capital mobility is now almost perfect across advanced economies. Between advanced and emerging economies, limits and restrictions still exist, but they have not prevented large capital flows from the former to the latter. As regards the mobility of persons, several developments linked to globalization have indubitably reduced the cost of moving and living abroad over the last 40 years: the cut in transportation costs, the extension of financial globalization and international communications through the internet, the harmonization of living standards across countries and the adoption of English as lingua franca at the world level, the international recognition of diplomas and skills, etc. There is unfortunately no direct synthetic indicator which encompasses those different elements. To portray the variation in the mobility of individuals, we rely on the KOF index of social globalization. Calculated and published by the Swiss Economic Institute, the general KOF index is the combination of three indexes, one economic, one social and one political.1 The social index itself combines three components: (i) the personal contacts, measuring the personal interactions between one country and abroad (telecom traffic, journeys, number of immigrants, number of letters), (ii) the flows of information between one country and abroad and (iii) the cultural proximity denoting the openness of the population to international cultural standards. A rise in all those components typically reveals a reduction of the cost of migrating and living abroad. Figure 1.13 displays the (unweighted) mean variation of the KOF index of social globalization for advanced countries as well as the ratio of between-country standard deviation to the mean since 1970. Those curves attest that (i) the cost of migrating and living abroad has indubitably fallen, and (ii) this fall concerns all advanced economies, and the between-country cost divergence has significantly shrunk. 1

See the presentation in Chap. 5, Sect. 5.1.2.3.

12

1

Globalization and Inequality: The Facts

Fig. 1.13 KOF index of social globalization, advanced countries Source: KOF Swiss Economic Institute. Non-weighted average. Advanced countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Israel, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the UK, the USA

1.2.2

Immigration

Figure 1.14 depicts the net immigration rate

Net immigration Total population

, (a) for the major

countries of immigration (France, Germany, the UK and the USA) and (b) for three groups of smaller countries (Anglo-Saxon ‘new’ countries, Scandinavia and South Europe). There is no clear trend in net immigration flows. The net immigration rate seems to fluctuate with different developments (business cycles, political turmoil in some countries, wars, etc.). In the four largest economies (Fig. 1.14a), the long-term trend displays a flat profile. An upsurge in immigration appears from the mid-2000s in the ‘new countries’ and in Scandinavia. Finally, South Europe displays an upward trend in immigration throughout the 1960–2015 period, moving from a position of net emigration to a position of net immigration. This specific profile reproduces the change in the development level of those countries. In consequence, even if the cost of international migration has indubitably shrunk and illegal migration has increased (in particular because of mafia-type networks), total immigration does not seem to constitute a key component of the new wave of globalization which has begun in the late 1980s/early 1990s. In addition, there are clearly significant differences across advanced countries in the phasing of immigration flows, the skill of immigrants and the type of immigration (for work, for family reunification, for war refugees, etc.).

1.2

Migration, Mobility of Tax Bases and Decrease in Tax Progressivity

13

Fig. 1.14 Net immigration rate*, 1960–2015 immigration Source: OECD stat. Population and Vital Statisics. *Net Total population . South Europe: Italy, Portugal, Spain. Scandinavia: Denmark, Norway, Sweden. New countries: Australia, Canada, New Zealand

1.2.3

Changes in the Tax Structures

Since the mid-1980s, the tax structures have known substantial modifications in advanced economies: 1. All the countries have significantly reduced their corporate tax rates (CTR), from about 50% on average in the early 1980s to about 20% in 2020. In addition, throughout the period, small countries’ corporate tax rates are always smaller than that of large countries (Fig. 1.15). 2. The top marginal income tax rates have fallen in all advanced countries in the 1980s and early 1990s, from almost 70% on average to less than 50%. From then on, they have fluctuated between 45% and 50% (Fig. 1.16a). 3. The top marginal tax rate standard deviation has continuously decreased since the late 1980s (Fig. 1.16b), moving from about 14% on average to about 4%. 4. Since 1980, the top inheritance tax rate has significantly decreased in the USA and the UK and slightly in Germany (France has a singular profile with an increase in the top rate). A number of countries (15 OECD countries) have removed inheritance taxation.2 5. The sum of the income tax rate and the social contribution rate of employees, which measures the levies on income, is decreasing (Japan, Germany, Belgium, Austria, Luxembourg) or flat (the UK, the USA, France) at the top of the income distribution in a large number of countries (Fig. 1.17).3

2

Jestl (2021) and OECD (2021a) for a presentation and comparison of inheritance tax regimes. As the OECD data do not provide the rate for incomes higher than 1.67 times the mean income, the tax regressivity for high incomes is probably underestimated in Fig. 1.17.

3

14

1

Globalization and Inequality: The Facts

6. The value-added tax (VAT) has almost continuously increased since 1980, with a rate moving from 16% to more than 19% in advanced economies on average (Fig. 1.18). Since corporate revenues are concentrated in the hands of rich taxpayers, the concomitant decreases in the CTRs and in the top marginal income tax rates denote a reduction in tax progressivity. This reduction is comforted by the rise in the VAT rates since this tax applies identically to all consumers.

Fig. 1.15 Average statutory corporate tax rate. (a) 1980–2005. Source: Takahashi et al. (2013), Table1. p.223, (b) 2000–2021. Source: OECD Stat. Combined (central + local) statutory corporate income tax rates (unweighted av.). Large advanced countries: France, Germany, Italy, Japan, the UK, the USA. Small countries: Austria, Baltic countries, Czech Rep., Hungary, Ireland, Luxembourg, Slovakia, Slovenia

Fig. 1.16 Advanced countries: top marginal income tax rates, 1980–2012. Source: OECD Stat. Non-weighted average taxþEmployee social security contribution Note: Income tax and social contribution rate = Central and local incomeGross . labour income

1.2

Migration, Mobility of Tax Bases and Decrease in Tax Progressivity

15

Fig. 1.17 Income tax and social contribution rate Source: OECD Stat. 2017 Values of the marginal ratio (y-axis) for 67, 100, 133 and 167% of the average income (x-axis). South Europe: Greece, Italy, Portugal, Spain. Nordic countries: Denmark, Finland, Norway, Sweden

Fig 1.18 OECD unweighted average VAT rate Source: OECD, consumption tax trends 2016. Chap. 2

16

1.3

1

Globalization and Inequality: The Facts

Public Social Expenditure and Public Debt

The increase in inequality has come with an increase in public social expenditure in Redistribution all advanced economies. The relative redistribution rate Pre‐tax&redistribution Gini has albeit remained almost flat from 1980 to the start of the COVID pandemic, which did not permit to offset the increase in the pre-tax and redistribution inequality (Figs. 1.9 and 1.10b).

1.3.1

General Increase in Public Social Expenditures

Figure 1.19 clearly attests that social public expenditures in percent of GDP have significantly increased in all advanced areas since 1980. The shape of this increase differs across country, and it typically depends (i) on the political colour of the incumbent government and (ii) on economic activity (social expenditures in percent of GDP tends to rise in periods of economic downturn and to shrink with recovery). Despite this general increase, one can observe substantial differences between areas. Throughout the 1980–2015 period, US and non-US Anglo-Saxon countries have relatively low social public expenditures, whereas those expenditures are high in Nordic countries and Continental Europe. South Europe and Japan exhibit the highest increase, the former moving from a position similar to the Anglo-Saxon countries to a situation which is now closer to that of Continental Europe and Nordic countries.

Fig. 1.19 Social public expenditure (% GDP). (a) Total, (b) Except unemployment and old age Source: OECD Stat. Notes: Non-weighted average for each country group. Continental Europe: Austria, Belgium, France, Germany, the Netherlands. Non-US Anglo Saxon countries: Australia, Canada, New Zealand, the UK. South Europe and Nordic countries: see the note under Fig. 1.17

1.3

Public Social Expenditure and Public Debt

17

Fig. 1.20 Relative redistribution rate Source: WIID, 2016. See the notes under Fig.1.16 for the calculations and composition of each - Post‐tax&redist:Gini country group.Relative redistribution rate = Pre‐tax&redist:Gini Pre‐tax&redist:Gini

1.3.2

Changes in Redistribution

Logically, redistribution has increased with social public expenditure. From 1980 to 2015, however, the relative redistribution rate measured by the ratio Pre‐tax&redist:Gini - Post‐tax&redist:Gini has remained broadly flat in the USA, in non-US Pre‐tax&redist:Gini Anglo Saxon countries, in Japan and in Nordic countries (Fig. 1.20), making posttax inequality increase approximately at the same rate as pre-tax inequality (Figs. 1.8 and 1.9). In Continental Europe, this ratio has moderately increased but not sufficiently to erase the pre-tax and redistribution increase in inequality (Figs. 1.20 and 1.9). South Europe is the only area in which the increase in redistribution has been sufficiently large to offset almost completely the increase in pre-tax inequality (Figs. 1.20 and 1.9). Nevertheless, South Europe remains inequality-oriented because it was highly unequal in 1980.

1.3.3

Increase in Public Debts

Since the early 1990s, the general public debt in percent of GDP has substantially increased in advanced economies, from 57% on average in 1990 to 89% in 2015 (non-weighted mean). This increase concerns all advanced areas except Nordic

18

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Globalization and Inequality: The Facts

Fig. 1.21 General public debt in % of GDP, 1990–2015 Source: IMF (A Historical Public Debt Database), Last update 2016. https://data.imf.org/?sk=80 6ED027-520D-497F-9052-63EC199F5E63&sId=1441803350568

countries (Fig. 1.21). The increase in the ratio of public debt to GDP is centred in two periods, 1992–1995 and 2008–2013. Combining Figs. 1.19 and 1.21, it can be observed that the periods of rising public debt correspond to the periods of growing social expenditures. This suggests that the increase in social expenditures has been to a large extent financed by the debt.

1.4 1.4.1

Unemployment, Skill Endowment and Labour Market Rigidity Unemployment

Figure 1.22 depicts the rates of unemployment in five advanced areas for successive 5-year time intervals from 1985 to 2019. Figure 1.23 compares the rates of unemployment for skilled and unskilled workers Figure 1.22 reveals three periods: 1. From 1985 to the late 1990s, there is a divergence between the USA which shows a decreasing and limited unemployment and Europe (except the UK) which displays a growing and high unemployment. Over this period, the UK moved from a European to an American profile.

1.4

Unemployment, Skill Endowment and Labour Market Rigidity

19

2. From the late 1990s to the 2008 financial crisis, all countries converge. 3. From 2008, the countries have had similar profiles (sharp increase during the financial crisis and reduction afterwards), with however a substantial increase in the unemployment gap between South Europe and other areas.

Fig. 1.22 Rates of unemployment Source: OECD Stat. Note: ratio Unemployment Labour Force . Mean for the time interval [t, t + 5[ Non-weighted average. Composition of country groups: see the note under Fig. 1.12

Fig. 1.23 Rate of unemployment by skill level Source: OECD Stat. Low skill: below upper secondary. Medium skill: upper secondary and postsecondary non-tertiary. High skill: tertiary. Composition of country groups: see the note under Fig. 1.12

20

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Globalization and Inequality: The Facts

Figure 1.23 clearly shows that unemployment is essentially, and perhaps solely in most advanced countries, an unskilled and middle-skilled labour issue. Full employment has always prevailed for skilled workers, except in the periods of economic recession. A last element deserves to be highlighted. Throughout the 35 years considered in Fig. 1.22, the variations and fluctuations are smoother in Continental Europe than in other advanced areas.

1.4.2

Skill Endowment

Since the late 1980s, there has been a general skill-upgrading in advanced economies. First, the share of the low skilled (below upper secondary) in the working population has substantially shrunk in all countries (Fig. 1.24). Second, the proportion of high skilled (tertiary education) has significantly increased (Fig. 1.25). In 2020, their share in the 25–65-year-old population of advanced countries is between 30% and 52%. The overtime profile share of the middle skilled (completed

Fig. 1.24 Low skilled in the population (%) Sources: 1980–2010: De la Fuente and Domenech Database on Education Attainment. http://pareto. uab.es/wp/2012/91112.xls; 2010–2020: OECD Stat. Dataset: educational attainment and labour force status/1980–2010, skilled groups in percent of the population 25 years old+. 2010–2020: skilled groups in percent of the population 25–65 years old. Definition of Nordic countries and South Europe: see the note below Fig. 1.17. Low skilled: below upper secondary. Middle skilled: upper secondary and non-tertiary vocational. High skilled, tertiary

1.4 Unemployment, Skill Endowment and Labour Market Rigidity

21

Fig. 1.25 High skilled in the population (%) Sources: 1980–2010: De la Fuente and Domenech Database on Education Attainment. http://pareto. uab.es/wp/2012/91112.xls; 2010–2020: OECD Stat. Dataset: educational attainment and labour force status/1980–2010, skilled groups in percent of the population 25 years old+. 2010–2020: skilled groups in percent of the population 25–65 years old. Definition of Nordic countries and South Europe: see the note below Fig. 1.17. Low skilled: below upper secondary. Middle skilled: upper secondary and non-tertiary vocational. High skilled, tertiary

secondary education and non-tertiary vocational studies) is different (Fig. 1.26). From the 1970s to the mid-1990s, it increased in all countries except the USA (where it began to decrease in the early 1990s). After remaining broadly unchanged from the mid-1990s to 2010, this share has then decreased in all advanced areas except South Europe. Finally, the between-country differences in (low, middle and high) skill endowments have shrunk, and advanced areas have converged in this respect over the last 40 years. Throughout the 1985–2020 period, the difference in skill endowment between advanced and emerging countries, particularly China, has remained significant (Fig. 1.27). In fact, the substantial upsurge in the skill level of emerging countries’ working population has come with a parallel skill upsurge in advanced economies which has lessened the skill catching up. This typically means that the North comparative advantage in skill has remained large throughout the analysed period of time. Nevertheless, the case of China where the proportion of tertiary students per generation has rapidly caught up the proportion in advanced countries since the mid-1990s (Fig. 1.28) shows that this comparative advantage could vanish in the forthcoming years. In 1980, the enrolment in tertiary education per generation was 24 times higher in advanced economies than in China and only 1.5 times higher in 2019.

Fig. 1.26 Middle skilled in the population (%) Sources: 1980–2010: De la Fuente and Domenech Database on Education Attainment. http://pareto. uab.es/wp/2012/91112.xls; 2010–2020: OECD Stat. Dataset: educational attainment and labour force status/1980–2010, skilled groups in percent of the population 25 years old+. 2010–2020: skilled groups in percent of the population 25–65 years old. Definition of Nordic countries and South Europe: see the note below Fig. 1.17. Low skilled: below upper secondary. Middle skilled: upper secondary and non-tertiary vocational. High skilled, tertiary

Fig. 1.27 Post-secondary education attainment, 25–64 years old, both genders, ratio area/China (%) Source: World Bank. Education Statistics (Wittgenstein Projection). Note: ratio of post-secondary attainment in the 25–64 years old (both genders) in the considered advanced area divided by the same ratio in China. Composition of Continental Europe, Nordic countries and South Europe: see the note below Fig. 1.12. Advanced economies: non-weighted average of 21 countries (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Sweden, Switzerland, the UK, the USA

1.4

Unemployment, Skill Endowment and Labour Market Rigidity

23

Fig. 1.28 Enrolment in tertiary ed. per generation ratio advanced countries/China (%), 1980–2019 Source: World Bank. World Development Indicators. Note: ratio of total enrolment, regardless of age, to the population of the age group corresponding to the level of education in advanced economies divided by the same ratio in China

1.4.3

Labour Cost and Labour Market Rigidities

1.4.3.1

Difference in Labour Costs Between Advanced and Emerging Countries

To the best of our knowledge, there is no long-term data comparing the labour cost (hourly wage in common currency) for the different advanced and emerging countries. We consequently rely on a very imperfect proxy which is the GDP per capita in current US Dollar. This indicator certainly amplifies the labour cost gap between advanced and emerging countries because (i) the MNEs typically pay more than domestic firms and (ii) earnings are higher in manufacturing than in agriculture and traditional sectors. When comparing countries, it can also be misleading because persons there are significant between-country differences in the ratio Working Total population . Nevertheless, a high difference in GDP/capita means a high difference in labour cost, and we focus on groups of countries, which permits to lessen the second bias. Figure 1.29 depicts the GDP per capita (current US Dollar) in China and emerging countries as a percentage of the GDP per capita in developed countries. Despite a substantial increase since the early 1990s, the Chinese GDP/capita is in current US Dollar of about one fifth of that of advanced economies in 2019. Likewise, the GDP/capital of emerging countries represents about 12% of that of developed countries in 2019. Those results suggest that the difference in labour cost between China and emerging areas on the one hand and advanced countries on the other hand remains significant in 2019 despite a reduction over the last 30 years.

24

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Globalization and Inequality: The Facts

GDP per capita in emerging countries Fig. 1.29 Ratio GDP per capita in developed countries (%) Source: CEPII. CHELEM database. The composition of developed and emerging countries are those of the CHELEM database

1.4.3.2

Labour Market Institutions

The labour market institutions are fairly different across advanced economies. From the end of WW2 up to the 1970s, Europe and the USA have followed similar developments with a strengthening of both the welfare state and labour market regulation. From the late 1970s to early 1980s, the two areas have to a large extent diverged, with a large labour market liberalization and a reduction of the welfare state in the USA and a preservation of a large part of the social net in Europe. In the 1980s, the UK reformed its labour market and welfare state in the same direction as the USA. The changes introduced in the 1990s have moderated this development, and the UK can now be seen as standing between the American and European ‘models’. In addition, all advanced economies have known a liberalization of their labour markets, but this general move has taken very diverse shapes and intensity across countries and over time. Finally, the fall in unionization, measured by the ratio of trade union members to the number of employees, is also a common development observed in all advanced economies, with once again important differences across countries. We firstly present several indicators characterizing labour market regulation which significantly differ across countries: the minimum wages and two indicators of strictness of employment protection, one on temporary contracts and the other on collective and individual dismissals. The three indicators testify to large differences between Anglo-Saxon countries, particularly the USA, and European countries (Continental Europe, South Europe and Nordic countries), Japan standing in between.

1.4

Unemployment, Skill Endowment and Labour Market Rigidity

25

wage Fig. 1.30 RatioMinimum Mean wage Source: OECD Stat. Labour. Mean per decade

Fig. 1.31 Strictness of employment protection, 1990–2019. (a) Temporary contract, (b) Dismissals (collective and individual) Source: OECD Stat. Labour. Scandinavia: Denmark, Norway, Sweden. Other country groups: see Fig. 1.12 wage As regards the minimum wages, we have selected the ratio Minimum which Mean wage permits to take into account the between-country differences in productivity (Fig. 1.30). As a number of advanced countries have not set a minimum wage (Scandinavia) and as this setting is recent for other countries (the UK in the 1990s, Germany in the 1010s), it is impossible to refer to our usual country groups. The comparison of the countries for which a minimum wage exists leads to the following two remarks: (i) there are huge differences across countries in the level of the minimum wage; (ii) Continental Europe (and more recently the UK) displays high minimum wages, whereas the USA and Japan enforce rather limited ones. Hence, the cost constraints linked to the minimum wage is high in the former and low in the latter countries. The OECD calculates indicators of the strictness of employment protection. Figure 1.31 displays those indicators for temporary contracts and for dismissals (both collective and individual).

26

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Globalization and Inequality: The Facts

Fig. 1.32 Union density, 1980–2019 Unionised workers Source: OECD Stat. Ratio Number of employees

For temporary contracts, we do not utilize our usual country groups which are not adequate to compare the different economies. The strictness of temporary contracts is quasi-nil for the USA and the UK. Since 1990, all other countries except France have experienced a decrease in the employment protection for temporary contracts, this protection remaining however significantly larger than those of the USA and the UK, particularly for France, South Europe and to a lesser extent Nordic countries and Germany. As regards protection against dismissals, the USA displays once again a specific profile, this protection being quasi-nil over the period 1990–2019. Other advanced countries do have protections against dismissals, Continental and South Europe being the most protective and non-US Anglo-Saxon countries the least protective. Finally, Fig. 1.32 clearly shows that the weight of unionized workers in the employed population has significantly decreased in the last 40 years in all advanced countries. The UK exhibits the largest fall, but the decrease has also been important in Germany and Nordic countries since the mid-1990s. In 2019, Nordic countries nevertheless remain the most unionized with a union density of 60%, the USA and France being the least unionized with a 10% density.

1.5

1.5

Major Stylized Facts

27

Major Stylized Facts

The developments highlighted in the preceding four sections draw a series of facts which underlie the mechanisms, explanations, theoretical models and econometric studies presented in the following chapters. First, a new wave of globalization started in the late 1980s/early 1990s which is characterized by the following features: 1. A substantial increase in the weight of emerging countries (the ‘South’) in the world trade of manufacturing, which is to a large extent due to China. 2. A large increase in the share of intermediate goods in trade which denotes the expansion of globalized value chains in which emerging countries play a key role. 3. A significant growth in FDI and particularly FDI flows to emerging countries made by multinationals. Those FDIs augment the South capital endowment and support technological transfers from advanced to emerging countries. 4. A substancial decrease in the mobility costs for physical and financial capital and for persons. Second, this new wave of globalization has come with a rise in inequality which has concerned all advanced economies but with different intensities, and the moves have been very unequal for the different income quantiles: 1. The USA have known the largest increase, followed by the non-US Anglo-Saxon and the Nordic countries. Continental Europe and South Europe have experienced the lowest increases. Nevertheless, as Nordic countries were initially very egalitarian and South Europe very unequal, the former remain equality-oriented and the latter inequality-oriented. 2. The increase in inequality has occurred despite a large skill upgrading of the population. This suggests that the demand for less-skilled workers should have significantly decreased. 3. The increase in inequality is observed in both the pre-tax and redistribution income and the post-tax and redistribution income. 4. The top quantiles (top 1%, top 0.1%) of the income distribution have substantially increased their share in total income. 5. The income share of the richest tax payers have increased more after tax than before tax and redistribution, which suggests that the changes in the tax system have favoured the top incomes. Third, the last 40 years have been characterized by major modifications in tax policies, budget policies and social policies: 1. The tax structure has deeply changed in all advanced countries. The corporate tax rates have decreased everywhere, and this reduction has been stronger in small than in large countries. The marginal income tax rates and the top inheritance rates have also decreased, whereas the value-added tax rates have risen. These moves have reduced the tax burden of the top income earners.

28

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Globalization and Inequality: The Facts

2. There has been an increase in social public expenditures in all advanced countries, but this increase has not been sufficient to offset the rise in the pre-tax and redistribution inequality. 3. The rise in social public expenditures has been associated with an increase in public debts (in percent of GDP) which has significantly augmented since 1990. Fourth, unemployment has been highly unequal both between advanced countries and across time, and there has been a general move of labour market liberalization which has also been uneven across countries, showing a clear divergence between the USA and European countries (Continental and South Europe, Nordic countries): 1. Three period of unemployment can be distinguished: (i) From 1985 to the late 1990s, a divergence between the USA with a decreasing and limited unemployment and Europe with a growing and high unemployment. (ii) From the late 1990s to the 2008 financial crisis, advanced countries converge towards a rather limited unemployment. (iii) Since 2008, all countries display similar profiles (sharp increase during the financial crisis and reduction afterwards), with a very large unemployment excess in South Europe. 2. The labour cost has remained significantly lower in advanced compared to emerging countries. 3. Even if there has been a general move towards labour market liberalization, substantial differences persist across advanced countries in terms of labour market institutions. 4. In terms of minimum wage, there is a large gap between Europe, including the UK, where it accounts for between 35 and 50% of the average wage, and the USA, where it represents only 25% of the average wage. 5. In terms of strictness of employment protection, there is a large divergence between the USA, where this protection is quasi-nil, and South Europe, Continental Europe and to a lesser extent Nordic countries, where the protection is rather high. 6. Unionization has decreased in all advanced countries.

Chapter 2

Trade and Inequality

Chapter 1 has revealed two major changes in the structure of international trade since the late 1980s/early 1990s. First, the weight of emerging countries (the South) in world trade has substantially increased, particularly in the exports of manufacturing. Second, a new international division of labour in which the different segments participating in the production of goods are located in different countries according to their cost advantage has become a key element of international trade. This extended offshoring of production segments and tasks has generated global value chains. Chapter 2 is centred on the impact of those new trade patterns on inequality in advanced countries. The first Sect. (2.1) analyses the development of North-South trade and the different mechanisms through which this development influences inequality in the North. The second Sect. (2.2) focuses on offshoring, global value chains and their impact on inequality. The third Sect. (2.3) presents the trade and technology interplays. Most of the analyses presented in those three sections are centred on inequality between skilled and unskilled workers and, to a lower extent, between labour and capital income. The fourth Sect. (2.4) introduces trade-driven polarization, in which medium-skilled workers are the main losers. As the increase in inequality is to a large extent driven by the increase in top incomes, Sect. 2.5 focuses attention on the impact of globalization on the ‘superstars’. The final Sect. (2.6) summarizes the major findings regarding the trade-inequality relationship in advanced economies. Chapter 2 leads to the following general diagnosis: North-South trade, particularly North-South offshoring and global value chains, has indeed fostered inequality in advanced economies by generating winners (high-skilled workers and capital owners) and losers (low- and medium-skilled workers). Nevertheless, it could have increased the real income per head in those countries provided that they had maintained full employment. Consequently, everyone could have won (Pareto optimality) if a share of the winners’ gains had been transferred to the losers. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4_2

29

30

2.1

2

Trade and Inequality

Comparative Advantage, North-South Trade and Inequality

The rise in inequality in advanced economies has been concomitant (i) with the rise in trade with emerging countries and (ii) with a large capital mobility allowing multinational firms to invest in those countries. Therefore, the difference in endowments with capital and technologies could be easily surmounted by transfers from the advanced to the emerging countries. In consequence, the key difference between advanced (the North) and emerging (the South) countries concerns their endowments with skilled and unskilled labour because labour mobility remains weak between the two areas. Since the skill endowment constitutes the major divergence between advanced and emerging countries, the best tailored approach to portray this difference seemed to be the North-South Heckscher-Ohlin-Samuelson model (henceforth NS-HOS model) with two countries (North and South), two factors (skilled and unskilled labour) and two goods (one skill-intensive and the other intensive in unskilled labour). This model appeared all the more appropriate as it predicts that NorthSouth trade generates winners and losers, the losers being the less skilled in the North, which typically increases inequality in this area. Unfortunately, this model also predicts a number of features which are contradictory with observed developments. Expanding the model by relaxing its most restrictive assumptions permits to erase several of those shortcomings.

2.1.1

The North-South Heckscher-Ohlin Approach and its Shortcomings

2.1.1.1

The Basic NS-HOS Model and Inequality

Consider a North-South Heckscher-Ohlin-Samuelson model with two countries, North and South; two factors, high-skilled labour H and low-unskilled labour L; and two sectors producing homogenous goods, one skill-intensive (H-intensive) denoted as h and the other low skill-intensive (L-intensive) denoted as l. Factor endowments are exogenous, and North is assumed to be relatively better endowed with skilled labour and South with unskilled labour: H N =LN > H S =LS , where H i and Li denote the endowment with skilled and unskilled labour in country i = N,S. As usual in HOS models, factors are internationally immobile, and both countries share the same technologies. Markets for goods and factors are perfectly competitive, which implies a unique price for each good and factor in integrated markets. The formal presentation of the North-South HOS model is exposed in Appendix A. In what follows,wH and wL denote the price (wage) of skilled labour and low-skilled labour respectively, and ω = wH/wL the skill premium which measures the wage benefit from being skilled rather than unskilled. For North and South,

2.1

Comparative Advantage, North-South Trade and Inequality

31

we then have ωN = wNH =wNL and ωS = wSH =wSL . Since ω = wH/wL > 1 in both countries, the skill premium can be interpreted as a measure of inequality between skilled and unskilled workers. We compare two situations, autarky versus free trade. This consists in comparing the pre-globalization period in which trade was essentially intra-North (the South being a raw material provider) and the emergence of the South as a key trade actor, particularly in the exports of manufacturing. Free trade is characterized by the total lack of trade costs (no trade barriers, no transport costs, no transaction costs, etc.). Hence, free trade implies that the same homogenous good has the same price in all countries (law of one price). Sector h depicts the skill-intensive goods (electronic, pharmaceutical industries, machine tools, aerospace industry, etc.) and sector l the standardized low skill-intensive goods (clothing, textile, toy industry, basic consumer goods, etc.). In the basic NS-HOS model, free trade leads to a situation similar to that resulting from the creation of a new ‘global country’ formed of the integration of North and South. This leads to the following results (formal proofs in Appendix A): 1. With free trade, North is specialized in the production and exports of the skillintensive good h and South in the production and exports of the low skillintensive good l. 2. Factor price equalization: At the equilibrium, the price of each factor is the same in both countries. 3. In both countries, there is an increase in the price of the relatively abundant factor and a decrease in the price of the relatively scarce factor (result of the StolperSamuelson theorem). In autarky, skilled labour is relatively better paid in South and low-skilled labour better paid in North, i.e. the skill premium is lower in North than in South: ωN = wNH =wNL < ωS = wSH =wSL . This is because skilled labour is relatively scarce in South and low-skilled labour relatively scarce in North H N =LN > H S =LS . As free trade acts as the formation of a new country integrating North and South, the relative endowment of this ‘global economy’ (denoted as G) is between those of North and South

HN LN

>

HG LG

=

H N þH S LN þLS

>

HS LS

. Conse-

quently, the skill premium at the global level is between the autarkic skill premia of North and South: ωN < ωG < ωS. Hence, the skill premium increases from ωN up to ωG in North and decreases from ωS down to ωG in South. 4. Since the skill premium measures inequality, inequality increases in North and decreases in South. 5. If a growing number of emerging countries with a low endowment in skilled labour integrate the global economy, the global relative skill endowment HG LG

=

H N þH S LN þLS

decreases which entails a rise in the global skill premium ωG,

reinforcing thereby the rise in inequality in North and lessening its reduction in South. 6. In North, low-skilled workers are twice hurt by North-South trade, first in relative terms since the skill premium increases and second in absolute terms because their real wage (purchasing power) decreases. In contrast, North skilled workers

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Trade and Inequality

are twice beneficial, first in relative terms and second in absolute terms because their real wage increases. 7. Nevertheless, Northern workers win on average because trade makes the North total income per capita increase. Results 6 and 7 show (i) that North-South openness creates winners (high-skilled workers) and losers (low-skilled workers) in advanced economies and (ii) that North workers win on average since the income per head increases in North. This means that there could be a way to make everybody win, or at least nobody lose, which consists in transferring part of the winners’ gains to the losers. In summary, the NS-HOS model predicts that North-South openness induces an increase in inequality in advanced countries and that inequality grows with the size of the South, i.e. with the number of emerging countries involved in the global economy. This result is in line with the observed changes in inequality exposed in Chap. 1. Unfortunately, the model leads to additional predictions which are at odds with observed facts. The whole list of unconfirmed predictions of the North-South HOS model is presented in Hellier (2013, Tables 4.1 and 4.2, p.113). The extensions which permit to correct the model and make it consistent with observed facts are precisely exposed in Hellier (2013, 2019). We now highlight the major shortcomings, and we explain how some changes in the assumptions can make the model coincide with the developments observed since the late 1980s.

2.1.1.2

Unconfirmed Predictions

The first unsuitable prediction concerns one key result of the HOS approach, i.e. a move towards factor price equalization which also signifies a convergence of the skill premia at the global level. As a matter of fact, the non-convergence is not only between advanced and emerging countries, it also affects intra-North and intra-South skill premia. As noted in Chap. 1, the 1980s and 1990s were characterized by a growing divergence in skill premia both between advanced countries and between emerging countries, and no skill premium convergence can be diagnosed between the two areas. A second unverified prediction is that in the basic NS-HOS approach in which both countries are inside the diversification cone,1 both North and South produce both goods, even if the former is specialized in the production and exports of the skill-intensive good and the second in low skill-intensive ones. In the 1990s, emerging countries did not produce high-tech and skill-intensive goods and segments. Today, the low skill-intensive tradable goods are no longer produced in advanced economies, and emerging countries have gone up the skill and technology

1

See the analysis of the diversification cone in the Sect. 2.1.2.

2.1

Comparative Advantage, North-South Trade and Inequality

33

ladder, even if the highest skill-intensive production segments are still produced in advanced economies. A third shortcoming of the NS-HOS model is that since all markets are assumed to be perfectly competitive, full employment is always ensured. Without mentioning the South, it is clear that in most advanced countries unemployment has increased since the mid-1970s and has been higher in the age of globalization that in the postWorld War II period (from the early 1950s to the mid-1970s). There are additional prediction failures such as the decrease in skill intensity in all industries and the increase in the relative price of skill-intensive goods in North. Those failures are however less important for our subject. A final shortcoming of the HOS framework is that it does not take into account the location of different production segments in different countries and the development of global value chains which are key elements of globalization. This point is analysed in Sect. 2.2. The extension of the NS-HOS approach by relaxing some of its simplifying assumptions allows correcting most of its unsuitable predictions. A detailed modelling of those extensions can be found in Hellier (2019). We focus here on the corrections which permit to erase the failures in terms of factor prices and skill premia equalization, of partial specialization and of unemployment: (a) large differences in factor endowments which entail the full specialization of at least one area and impedes factor price equalization, (b) differences in productivity and technology which make skilled and unskilled labour better paid in North than in South, (c) labour market imperfections which foster unemployment in North and (d) a larger number of countries and sector.

2.1.2

Divergence in Factor Endowments, Non-equalization in Factor Price and Stages of Globalization

As already noted, the equilibrium of the basic NS-HOS model is obtained by integrating North and South in a new global country whose factor endowments are the addition of those of both areas. Then, the new global factor prices and the new global skill premium are the equilibrium values corresponding to this global country S , for the given technologies of each sector and the relative endowment HL G = HLN þH þL G

N

S

demands for each good. But this reasoning disregards the fact that North and South are not fully integrated because factors are internationally immobile. As explained hereafter, this modifies the analysis when the difference in factor endowments is high between North and South. Consider the free trade global equilibrium with factor price and skill premium equalization defined by the basic NS-HOS model. For the so-determined skill premium, there is a unique skill intensity (ratio of the skilled labour to the unskilled labour utilized in production) in each sector (h and l). We denote ηh = Hh/Lh and ηl = Hl/Ll those fully determined values in the H-intensive sector h and the

34

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Trade and Inequality

Fig. 2.1 The diversification cone

L-intensive sector l, respectively. We have by definition of each sector: ηl < ηh. Then, for the global equilibrium with skill premium equalization to hold, the relative skill endowment of each country, H N =LN and H S =LS , must stand between those skill intensity values: ηl ≤ H S =LS < H N =LN ≤ ηh . This is because the highest possible skill intensity in North corresponds to this area producing skill-intensive goods only and, for full employment to prevail, the North relative skill endowment H N =LN must then be at the most equal to the skill intensity ηh. Likewise, the lowest possible skill intensity in South corresponds to this area producing unskilled labour-intensive goods only, and then the South must have a relative skill endowment H S =LS at least equal to ηl so as to preserve full employment. The values ηh = Hh/Lh and ηl = Hl/Ll draw a cone in the map (L,H) as depicted in Fig. 2.1, and the skill endowments of both North and South must then stand inside this diversification cone.2 What happens if the endowments of one of the two countries (or of both) are outside the cone? This typically happens when the difference in skill endowments between North and South is sufficiently large. Figure 2.2 illustrates the case in which South is below the diversification cone. Then, the South endowment in unskilled labour is too high to ensure full employment of its unskilled workers with the skill premium ωG corresponding to factor price equalization. With this skill premium ωG, the highest factor utilization is the couple H S , LS with LS < LS , which induces unemployment of low-skilled labour

2 This is called ‘diversification cone’ because being inside the cone is the condition for the production of both goods in both countries, i.e. for a diversification of production in both countries.

2.1

Comparative Advantage, North-South Trade and Inequality

35

Fig. 2.2 South outside the diversification cone

U SL = LS - LS (Fig. 2.2). This situation is not sustainable because competitive unskilled labour market makes the unskilled wage to decrease in South, re-establishing thereby full employment. The free trade equilibrium is then characterized by the following features: 1. The skill premium is higher in South than in North. 2. South only produces the low skill-intensive good, whereas North produces both goods. 3. The exchange rate between North and South ensures the same price for the unskilled-intensive good at the world level. In addition, since South produces L-intensive goods only, the share of H-intensive goods in North production is higher as well as inequality compared to North in autarky. All those results derive from a large difference in skill endowments which entails that both countries are not simultaneously in the diversification cone. The assumption that North and South are not simultaneously inside the diversification cone is realistic because (1) the difference in skill endowments between advanced and emerging countries was and is still substantial3 and (2), in the 1990s and early 2000s, emerging countries only produced low skill-intensive goods. Nevertheless, the specialization of both advanced and emerging countries has 3

In the 1990s, the share in the population of workers with tertiary degrees accounted for about 30% of the working population in advanced economies against between 5% and 10% in emerging countries, i.e. four times more in advanced countries.

36

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Trade and Inequality

changed with time from a situation in which the former produced both skill- and low skill-intensive goods and the latter L-intensive goods only to a situation in which advanced economies only produce H-intensive goods and emerging economies have gone up the skill ladder. Those changes in the countries’ specialization can be modelled by assuming a globalization dynamics defined as an increase in the size of South compared to North. This assumption pictures the fact that a growing number of developing countries and regions integrate the globalized economy. More precisely, we assume that the North working population H N þ LN and its skill relative endowment H N =LN remain constant, whereas the South working population H S þ LS increases with an unchanged relative endowment H S =LS : As H S =LS < H N =LN , the growing size of S South makes the global relative skill endowment HLN þH decrease. If North and South þL N

S

are inside the diversification cone, the global skill premium increases (since skilled labour becomes increasingly scarce at the global level), and inequality augments in North. More interesting is the case in which the divergence in skill endowment is high enough to make the two areas not to be simultaneously in the diversification cone. It can then be shown that the increasing size of South generates three stages (Hellier, 2013, 2019): 1. As long as the size of South remains relatively small, North produces both goods, whereas South produces L-intensive goods only. This corresponds to North being inside and South outside the diversification cone. During this first stage, the growing size of the South entails a continuous increase in inequality (the skill premium) in North. This is because the North produces less and less unskilledintensive goods, which lessens the demand for unskilled workers. 2. With the growing size of South, a moment comes when each country is fully specialized in the production of one good only, North producing the H-intensive good and South the L-intensive one. 3. Finally, when South becomes sufficiently large compared to North, the former produces both L-intensive and H-intensive goods, and North produces skillintensive goods only. Stages 2 and 3 are characterized in North by a constant skill premium, inequality remaining unchanged at the (typically high) level reached at the end of stage 1. As regards North workers’ purchasing power, the three phases substantially differ. The first phase is characterized by a growing real wage of skilled workers and a decreasing real wage of unskilled workers in North. In contrast, both skilled and unskilled workers’ purchasing power improves during stages 2 and 3 (see the proofs in Hellier, 2019, Appendix 5).4

4

In phase 1, North produces both goods, and since (i) prices are combinations of the skilled and unskilled wages and (ii) the skilled wage increases in relation to the unskilled wage, then the real unskilled wage (wage/price) decreases. In phases 2 and 3, the relative price of good h in terms of good l increases, and all North wages increase at the same rate as the price of good h because North produces this good only. Hence, as the price index combines both goods, the real wages rise in North.

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37

It must finally be stressed that if inequality remains unchanged and the unskilled workers’ purchasing power improves in stages 2 and 3 of globalization, this occurs after a huge increase in inequality and a decrease in the unskilled real wage during stage 1. This means in particular that (i) inequality remains high during stages 2 and 3 and (ii) the upturn in unskilled real wage can occur at a very depressed level of purchasing power.

2.1.3

Differences in Productivity and Technology

The HOS approach assumes a free access to technologies. Consequently, all countries utilize the same most efficient technologies. In the initial model, this assumption permitted to focus on purely factorial comparative advantages in contrast with the Ricardian approach centred on between-country technological differences. In the NS-HOS framework, this assumption is justified because globalization is now characterized by a large international mobility of capital and technologies linked to the multinationalization of firms. Nevertheless, there are still non-negligible differences in productivity between emerging and advanced economies, particularly when a lagging economy enters the globalized market. This is due to the lack of infrastructures, management and skill deficiencies, corruption, etc. The productivity gap tends however to fade with the country’s catching up. In addition, certain countries and firms continue to utilize traditional production processes even when more modern technologies are disposable. The productivity gap between North and South can be introduced in the NS-HOS model by assuming lower total factor productivities (TFP) in the South. Denoting Ah and Al the TFP in the production functions of sectors h and l in North, the related TFP are now λ × Ah and λ × Al in South, with λ < 1. The South productivity catching up makes λ tend towards 1. It can be easily seen that this is equivalent to having one unit of (skilled or unskilled) South labour being equal to λ < 1. unit of North labour. Then, if both North and South are inside the diversification cone, the South wages are obtained by multiplying the North wages by λ < 1, and both skilled and unskilled workers are better paid in North than in South. Catching up makes the South wages converge towards those of North. If the North-South difference in factor endowment is sufficiently large to impede that both countries produce simultaneously both goods, then the productivity gap just acts by lowering the South size (in terms of equivalent North labour), and the productivity catching up acts as a speeding up of the growing size of South. Finally, if the productivity gap differs across sectors, then South and North cannot simultaneously produce both goods even if they are both in the diversification cone, which is the usual Ricardian result. As it is logical to assume that the productivity gap is larger in the skill-intensive sector, this reinforces the likelihood that the South produces L-intensive goods only at the beginning of the globalization process.

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The maintenance of traditional technologies in certain emerging countries, even when more advanced and productive technologies are available, can be explained when the cost of unskilled labour is especially low.5 As a matter of fact, traditional technologies gather two major characteristics. They firstly suffer a low total factor productivity (TFP) compared to more advanced technologies; this encourages their rejection when modern technologies are available. They are secondly more unskilled labour-intensive than advanced technologies; this makes them beneficial when unskilled labour is cheap. There are thus two opposite effects on profitability when moving from a traditional to a more advanced technology. The TFP effect improves profitability, whereas the unskilled intensity effect reduces it. Hence, when the emerging country has a sufficiently low-unskilled labour cost, it can be more profitable to maintain the traditional technology rather than adopting the more productive but less unskilled-intensive modern technology. When considering several South countries producing good l only and differing in their skill endowments, those with a very high relative endowment in unskilled labour have a very low cost of unskilled workers and are thereby incited to maintain their traditional technology. In summary and as regards the impact of NS trade on inequality in North, the introduction of a North-South technological gap and technology catching up (i) reduces the inequality impact of trade with South at the beginning of the globalization process (since it acts as a reduction in South size) and (ii) subsequently accelerates the increase in inequality (since it acts as speeding the rise in South size up). This can explain why the empirical works implemented in the 1990s found a weak impact of North-South trade on inequality in advanced economies, whereas the subsequent studies have diagnosed a more sizeable influence.

2.1.4

Labour Market Failures and Unemployment

In the NS-HOS model, assuming perfect competition in labour markets logically results in full employment. To generate unemployment, it is thus necessary to assume imperfections in the labour market(s) preventing wage adjustments. We centre our attention to the case of unemployment in advanced economies. Two types of market imperfections can be considered. The firsts result from public policies and labour market institutions such as minimum wage, trade unions and wage bargaining, social transfers which increase the reservation wage, etc. Others are linked to the behaviours of private agents maximizing their utility (households) and profits (firms), such as efficiency wage approaches. Obviously, those channels are not independent from each other, and labour market institutions can favour certain behaviours which occur even when those institutional constraints do not exist. We firstly expose the general mechanism put forward by Krugman (1994) to

5

See the demonstration and precise definition of the condition to maintain traditional technologies in Hellier, 2019, Sect. 5.2.

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39

explain how differences in labour market institutions can make countries diverge in terms of inequality and unemployment. We subsequently focus on two major labour market imperfections, namely, (i) the setting of a minimum wage and institutions impeding wage adjustments and (ii) the efficiency wage behaviour.

2.1.4.1

Institutional Constraint and the Inequality-Unemployment Trade-Off

In the early 1990s, a number of economists made the diagnosis of a divergence between the USA and Europe in terms of inequality and unemployment. The USA experienced a large increase in inequality (‘America penniless’), whereas Europe suffered a large increase in unemployment (‘Europe jobless’). Krugman (1994) explained this divergence by differences in social policies and labour market institutions. His reasoning can be pictured by Fig. 2.3. Consider a country with a skill endowment H=L which is also the relative skill supply. The relative demand for skilled labour Hd/Ld is depicted by curve D as a decreasing function of the relative factor price, i.e. of the skill premium ω  wH/wL. Market clearing determines the equilibrium skill premium ω. Suppose now a demand shock which raises the relative demand for skilled labour Hd/Ld from D up to D′. If labour markets are perfectly competitive, then the adjustment operates through prices, and the skill premium rises, moving from ω to ω0 and increasing thereby inequality. In contrast, if social policies or labour market institutions (minimum wage, wage bargaining, social transfers increasing the reservation wage, etc.) fully or partially prevent the skill premium adjustment, then earnings inequality is shortened, but this happens by increasing the unemployment of unskilled workers. In Fig. 2.3, the partial adjustment of the skill premium ω generates the unskilled unemployment UL. This story shows that governments are confronted with an

Fig. 2.3 Adjustment with an institutional constraint on the skill premium

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inequality-unemployment trade-off. If technological change and/or globalization create an increase in the relative demand for skilled labour, the policy-maker can either let the market do, which increases inequality, or prevent the rise in inequality, which generates unemployment.

2.1.4.2

Impact of a Minimum Wage and Extension to Downward-Rigid Wages

In the NS-HOS model with North and South not being together inside the diversification cone, North and South never produce simultaneously both goods, and factor prices differ across countries. As a consequence, the skill intensity in the sector in which they concurrently produce can differ, and the countries’ factor utilizations are independent from each other, depending on factor prices only. In this framework, the relative factor price (skill premium) in North determines the factor intensity in each sector. When labour markets are perfectly competitive, the full utilization of the North endowment H N , LN determines the full-employment equilibrium North skill premium ωN . Consider now the situation in which the North government sets a minimum wage which corresponds to a maximum skill premium ω lower than its full-employment value: ω < ωN . This minimum wage acts as a price constraint on the unskilled labour market only, the skilled labour market remaining competitive. As the skilled labour relative price decreases compared to its full-employment value, the relative skill utilization (intensity) increases in North, and for a given endowment H N , the unskilled labour utilization shrinks, generating thereby unemployment of the North unskilled workers. What happens now when both countries produce both goods (they are both inside the diversification cone), one of them setting a minimum wage and not the other? This question was tackled in the case of two advanced countries (Europe and the USA) with the same factor endowment by Davis (1998a). In Davis’ Europe-US HOS model, Europe enforces a minimum wage, and competitive labour markets prevail in the USA. The minimum wage is defined as a maximum skill premium. The model leads to the outcome that the minimum wage finally applies to both countries (because of factor price equalization), the European economy concentrating alone the so-generated global unemployment. Hence, the pro-equality policy pursued by Europe generates more equality in the USA as well, but the related global unemployment is paid by the sole Europe. To understand the mechanism leading to this result, let us start with both countries being at the full-employment global skill premium ω and make Europe set a minimum wage, i.e. a maximum skill premium ω < ω . The setting of a minimum wage makes the cost of producing unskilled-intensive goods lower in the USA than in Europe. Hence, the production of unskilled-intensive goods moves to the USA, increasing thereby the demand for American unskilled workers and making the US skill premium to fall. This move only stops once this decrease has made the American skill premium attain the value ω for which the USA no longer benefit from a cost advantage in the production of unskilled-intensive goods. Thus,

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41

the mechanism rests on the relocating to the USA of a share of the European production of unskilled-intensive goods, i.e. an increasing specialization of Europe in the skill-intensive sector. Full employment is all time preserved in the USA. In contrast, the new specialization reduces the demand for European unskilled labour, and all the world unemployment due to the setting of the minimum wage concentrates thereby in Europe. In addition, the European minimum wage fully insulates the USA from shocks which increase the relative demand for skilled labour such as skillbiased technological change or the introduction of emerging countries producing Lintensive goods. Here again and through the same mechanism, the USA is preserved from growing inequality by the European minimum wage, and Europe concentrates all the related unemployment. The problem with Davis’ results is that they are in contradiction with facts. Following Davis’ model, we should have observed (i) an increase in unemployment in Europe and not in the USA, (ii) a decrease in inequality (or at least the same variation in inequality) in Europe and in the USA and (iii) a move of specialization towards unskilled-intensive sectors in the USA and skill-intensive sectors in Europe. Only the first of those three predictions is true. Inequality increased far more in the USA than in Europe, and the USA has specialized in more high-tech and skillintensive sectors than Europe. To make the model coincide with observed developments, a solution consists in removing the assumption of factor price equalization (Oslington, 2002). Then, Europe and the USA do not produce both goods at the same time. In fact, within a two goods×two factors×two countries HOS-type model, it is possible to obtain (i) a large increase in inequality without unemployment in the USA, (ii) no change (or a limited increase) in inequality and rising unemployment in Europe and (iii) a specialization in high-tech skill-intensive goods in the USA, by assuming that (1) the USA has a technological comparative advantage in the skill-intensive sector, (2) there is a skill-biased technological change in this sector and (3) Europe sets a minimum wage. If the USA has a comparative technological (Ricardian) advantage in the skill-intensive sector, two country specializations are possible: (1) the USA produces the H-intensive good only and Europe both goods and (2) the USA produces both goods and Europe the L-intensive good only.6 In both cases, skill-biased technical change in the H-intensive sector increases the demand for skilled workers in the USA (in Europe too in the first case but significantly less than in the USA) and thereby inequality in this country. The setting of the minimum wage increases unemployment and reduces the skill premium in Europe. The problem with this story is that it is essentially based on skill-biased technological change, and there is no impact of North-South trade. When modifying the model by inserting an emerging country which produces unskilled-intensive goods only, we add a new channel which increases inequality in

6

The case in which the USA produces the H-intensive good only and Europe the L-intensive good only is disregarded because it corresponds to a very large between-country difference in factor endowments, which is not the case between the USA and Europe.

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Europe and in the USA. If they both produce both types of goods, adding a minimum wage in Europe leads to the usual Davis’ results: the minimum wage applies in both countries, Europe concentrates all the related unemployment, and Europe is more specialized in skill-intensive goods than the USA. To mimic observed developments, it is then necessary to add a skill-biased technological change in the sole American skill-intensive sector which makes the USA be specialized in this sector only. This leads to the following results: (1) the USA produces skilled-intensive goods only and experiences a technology-related increase in inequality, and (2) Europe produces both goods, and its inequality is moderated by the minimum wage which entails unemployment of European unskilled workers essentially due to the relocation to emerging countries of a share of the production of unskilledintensive goods. This picture is consistent with the major developments observed in the 1990s and early 2000s, in particular with the results of several works showing that the increase in inequality is essentially explained by technological change in the USA, whereas globalization, particularly North-South trade, has a broader impact in most European countries. Finally, Davis (1998b) has analysed within an HOS framework the impact of different types of technical change (sector-biased, factor-biased, local or global). He only focuses on two stylized facts: (1) the relative wage of unskilled workers has more deteriorated in the USA than in Europe, and (2) unemployment rises in Europe and not in the USA. He finds that when assuming a minimum wage in the sole Europe, only three cases are consistent with stylized facts: (1) a global unskilled labour-saving technical progress concentrated in the unskilled-intensive sector, but this is not coherent with the fact that the US specialization is more skill-intensive, (2) a purely European unskilled labour-saving technical progress concentrated in the unskilled-intensive sector, and (3) a purely American unskilled labour-saving technical progress concentrated in the skill-intensive sector. The analyses presented above can be extended to most cases in which policies and labour market institutions increase the unskilled wage above its full-employment value in advanced countries. When assuming the existence of labour unions which impose an unskilled wage above the level ensuring full employment, the Europe-US HOS model and the NS-HOS model provide results which are similar to those presented with a minimum wage.7 Public transfers and/or labour market institutions which push the reservation wage (wage below which individuals refuse to work and prefer to remain unemployed) above the full-employment wage can be analysed in the same way. Nevertheless, the precise analysis of the influence of North-South openness should integrate its impact on social policies and labour market institutions themselves. This is examined in Chap. 4.

7

The case of union bargaining is analysed in Chap. 4.

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2.1.4.3

43

North-South Trade, Efficiency Wage and Unemployment

The preceding analyses have focused on social policies and labour market institutions which make the unskilled wage downward rigid. Another mechanism which prevents wage adjustment is the efficiency wage behaviour of firms. Within an approach à la Shapiro and Stiglitz (1984), the efficiency wage is principally determined by institutional factors (unemployment subsidies, social transfers, etc.). We shall therefore focus on the fair wage approach à la Solow (Solow, 1979) in which the workers’ effort depends on how ‘fair’ they consider their wage. Egger and Kreikemeier (2009) assume a fair wage based on the firm’s productivity and firm heterogeneity (à la Melitz, 2003) within a general equilibrium model in which globalization consists in a decrease in trading costs. They show that globalization leads to an increase in both profits (inequality) and unemployment. We focus now on the introduction of the fair wage hypothesis within the NorthSouth Heckscher-Ohlin approach. A formal presentation of a simple NS-HOS model with fair wage is exposed in Appendix B. To simplify, let us assume that the efficiency wage concerns the sole unskilled workers (i.e. the market for skilled labour is perfectly competitive) in North. Consider an NS-HOS model in which production depends in each sector (i) on skilled labour and (ii) on unskilled labour multiplied by the effort of unskilled workers. The effort depends on wage. More precisely, the effort is an increasing function of the unskilled relative wage, i.e. it decreases with the skill premium ω = wH/wL. In addition, the effort is assumed to increase with the unemployment rate. The first feature means that the larger the inequality between skilled and unskilled workers, the more unskilled workers consider their wage as unfair and reduce thereby their effort. The second feature is explained by a higher probability to be unemployed when the wage is high. As usual in such models, the firms in both sectors determine the efficiency wage and the efficiency skill premium which correspond to the maximization of profit subject to (i) the technological constraint and (ii) the workers’ effort function firms are assumed to know. According to Solow relationship,8 the efficiency wage does not depend on the production function for a given unemployment rate. Hence, both sectors share the same efficiency wage, and its enforcement by all firms results in unemployment of the less skilled.9 Suppose now that the before North-South (NS) openness equilibrium is characterized by a low unemployment of the unskilled. What is the impact of NS trade on this equilibrium? It increases the full-employment skill premium which, for the current efficiency skill premium, makes unskilled unemployment to increase. In return, higher unemployment reduces the efficiency wage and increases the efficiency skill premium. The total result is thus an upsurge both in inequality (the

8

Solow relationship stipulates that the efficiency wage is such that the elasticity of effort with respect to wage is equal to 1. 9 Note that unemployment is moderated by the fact that the fair wage decreases with the unemployment rate.

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efficiency skill premium increases) and in unemployment. This is what was observed in most advanced countries in the 1990s. The between-country difference in the inequality-unemployment balance can then reflect cultural and institutional differences. This balance depends on the sensitivity of effort to unemployment.

2.1.5

A Large Number of Countries and Sectors

One of the major stylized facts highlighted in Chap. 1 is that advanced countries substantially differ in their levels and variations in inequality. The NS-HOS approach is inadequate to analyse this feature since it assumes one advanced country only. Nevertheless, we have already explored situations with several advanced countries pursuing different policies when presenting the Europe-US HOS approach and when discussing the impact of efficiency wage behaviours. We now introduce, on top of policy and institutional differences, between-country divergences in skill endowment. Firstly, consider the NS-HOS approach (two sectors and factors) with the globalization dynamics defined by a growing size of South (Sect. 2.1.2), and assume that there are n Northern countries with different skill endowments, λi = H i =Li , i = 1, ⋯, n. Northern countries are ranked by decreasing order of skill endowment: λ1 > λ2 > ⋯ > λn. At the beginning of the globalization process, South is small and produces unskilled-intensive goods only, whereas all Northern countries (the North) produce both goods and have thereby the same skill premium. Its growing size makes South to conquer a growing market and production share of L-intensive goods. As already noted, this makes the North to increasingly specialize in H-intensive goods, with an increase in the skill premium and thereby a decrease in skill intensities in both sectors in the North. With this continuous decrease in skill intensity, a moment comes when the skill intensity in the production of skillintensive goods becomes equal to the skill endowment of the most skilled country, i.e. Country 1. From then on, Country 1 produces the skill-intensive good only, and its full-employment skill premium is fully determined by its relative skill endowment λ1 = H 1 =L1 and sector h technology.10 The continuing decrease in skill intensity in Northern countries producing both goods makes that the skill intensity in the skillintensive sector attains the relative skill endowment of a growing number of Northern countries (successively, Country 2, Country 3, etc.), making those countries produce the skill-intensive good only with their skill premium being then fully determined by their skill endowment and sector h technology. The higher the country’s skill endowment, the lower its full-employment skill premium. Once all Northern countries produce the skill-intensive good only, the hierarchy in inequality is the exact opposite of the hierarchy in skill endowment. Logically, the higher the country’s proportion of skilled workers, the lower their relative pay, and the lower

10

Remember that sector h is the skill-intensive sector and sector l the unskilled-intensive sector.

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45

the country’s inequality. This story generates three stages in the globalization process: 1. Stage 1: As long as the size of South remains small, all Northern countries produce both goods and have the same skill premium, and the unskilled real wage decreases in all of them. South produces the L-intensive good only. 2. Stage 2: With the growing size of South, an increasing number of Northern countries produce the skill-intensive good only, the firsts to do so being those with the highest skill endowment. This makes the intra-North skill premia and inequality to diverge, the hierarchy in inequality being the inverse of the hierarchy in skill endowments. The skilled and unskilled real wages increase in the Northern countries producing H-intensive goods only, whereas the real wage increases for the skilled and decreases for the unskilled in those producing both goods. South produces L-intensive goods only.11 3. Stage 3: All Northern countries produce the skill-intensive good only, all the Northern skill premia remain constant, and the across-country hierarchy of skill premia is the inverted picture of the hierarchy of skill endowments. The skilled and unskilled real wages increase in the North. South produces both goods. Finally, in stages 2 and 3, if social policies or labour market institutions render the unskilled wage downward rigid in a Northern country producing the H-intensive good only, this country suffers unemployment of its unskilled workers. The above reasoning is made by assuming several Northern countries and two sectors (goods). What happens when supposing a large number of goods differing in their skill intensity? Hellier and Chusseau (2010) developed an HOS-type model with n Northern countries, one emerging area and a continuum of goods on the skill intensity interval [0, 1],12 each good being identified by its position in this interval. The emerging area (the South) has the lowest skill endowment, and globalization is defined by an increase in its size (population). Northern countries are ranked by increasing order of skill endowment. Within such a framework, the countries’ specialization are distributed in the goods (skill intensity) interval as depicted in Fig. 2.4 for n = 3. The South produces the goods with the lowest skill intensities, and Northern countries are ranked in the goods (skill intensities) interval [0, 1] by increasing order of skill endowment. In Fig. 2.4, the South produces the goods in the skill intensity interval [0, ηS], Northern Country 1 produces goods with a rather low skill intensities (interval [ηS, η1]), Country 2 produces goods with medium intensities (interval [η1, η2]), and Country 3 produces the most skill-intensive goods (interval [η2, 1]). As specializations are determined by cost advantages, the higher a country in the

11 This feature holds because we have assumed that no Northern country is inside the diversification cone with South. Waiving this assumption could make South produce both goods at the same time as certain Northern countries with a low-skill endowment. 12 Hence, the first good (good 0) utilizes unskilled labour only and the last (good 1) skilled labour only.

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Fig. 2.4 Several countries with different skill endowments

skill intensity ladder, the lower its skill premium. The hierarchy of skill premia is then ω3 < ω2 < ω1 < ωS. What is the impact of the increasing size of the South on inequality? All the countries’ specializations move to the right. Hence, all Northern countries go up the skill intensity ladder (they produce goods increasingly skillintensive), and their demands for skill increase, moving their skill premium and inequality upward. But this general increase in inequality is uneven across countries. The rise in the skill intensity of production is the largest for country 1 (the Northern country with the lowest skill endowment and the highest initial inequality) and the lowest in Country 3 (the Northern country with the highest skill endowment and the lowest initial inequality), Country 2 being in-between.13 Consequently, Country 1 has the highest increase in its skill premium and inequality, Country 3 has the lowest, and Country 2 is in between. In addition, any public policy and/or labour market rule which prevents the wage adjustments generates unemployment, and this unemployment is larger in countries with a higher increase in inequality. Finally, the more inegalitarian a country is at the eve of the globalization process, the higher his globalization-related increase in inequality, and the greater its inequalityunemployment trade-off. The results presented in this subsection with several Northern countries and with two or a large number of sectors (goods) are rather consistent with what has been observed among advanced European countries since the 1980s. In the late 1970s, i.e. before the present wave of globalization, South Europe was inequality-oriented with a low skill endowment; Nordic countries, the Netherlands and to a lesser extent Germany and the UK were egalitarian with a relatively high skill endowment; and France and Belgium were in between. Despite a large increase in their skill endowment due to an effort in education, South Europe still has a skill gap compared to North Europe, and it has experienced high unemployment and maintained high inequality. On the opposite side, Nordic countries and the Netherlands have known (i) an increase in inequality which remains however rather low and (ii) a moderate or no increase in unemployment. Belgium, France and the UK have been in between with a rather high unemployment and no rise in inequality for the formers and a rather high increase in inequality and moderate unemployment for the latter. Germany has known a specific development (see Beissinger et al., 2016). Before the reunification, its characteristics were similar to those of the Netherlands. Since then,

13

The extension of the South set of goods has the highest impact on the country which is the closest to the South and a decreasing impact when moving away from South on the skill intensity ladder. This is because the total North skill intensity interval is bounded at its upper limit by 1 (Fig.2.4).

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two different periods can be distinguished. From the mid-1990s to the early 2000s/ mid-2000s, the German profile was similar to that of France, with a relatively low inequality and high unemployment. From then, i.e. after the labour market reforms of the late 1990s and the Hartz laws, this profile is closer to that of the UK, with low unemployment and higher inequality and poverty. Those developments appear in line with the results found when assuming several Northern countries and sectors within an NS-HOS framework with differences in labour market institutions and social policies. In contrast, the results of this subsection are clearly inadequate for explaining the divergence between the USA and Europe. Indeed, the USA has a high skill endowment and should thereby have experienced a lower inequality than Europe, and its inequality-unemployment trade-off should be weaker. Stylized facts suggest the exact contrary. Once again, assuming a skill-biased technical change significantly larger in the USA than in Europe is necessary to understand the American specificity.

2.1.6

Capital and Capital Mobility

We have until now considered two factors of production, skilled and unskilled labour. The justification for this assumption was that capital is internationally mobile and that only immobile factors are relevant to define the countries’ specialization in trade in the Heckscher-Ohlin approach. However, internationally mobile factors should also be considered to determine factor payments and thus inequality.14 The fall in the labour share of total income and the related rise in the capital share are key stylized facts, the explanation for which requires the introduction of capital formation. Since the early 1970s, the labour share has fallen in all advanced countries except the UK (Autor et al., 2020a, b, Fig. 1 p. 647). The decline in the price of capital can explain the rise in the capital share when the elasticity of substitution between labour and capital is higher than 1 (Karabarbounis & Neiman, 2013). Trade and offshoring, particularly with China, provide direct explanations for the fall in the price of capital and of ICT (Elsby et al., 2013). Another trade-based explanation for the decline in the labour share could derive from the trade-based concentration of firms. Within a Melitz-type framework (2003), openness makes the most productive firms export, grow in size and increase their profits. Increasing profitability raises the profit share in total income (Autor et al., 2020a, b). Finally, the increase in the capital share can be explained within an NS-HOS framework. So as to be in line with facts, let us add to this model a third factor,

14

Mundell’s inverted theorem states that when factors are perfectly mobile and goods immobile, then factor price equalization occurs as in the HOS model, but this is achieved through factor relocation.

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capital K, which is perfectly mobile internationally in open economy. We assume between-factor substitutability with the same elasticity of substitution between K and L, K and H and H and L (the case of differences in between-factor substitution is analysed in Sect. 2.3.1). We further assume that the North relative endowment with capital is higher than that of South, so that in autarky (immobility of goods and factors) the return to capital R is higher in South than in North. Then, openness (perfect mobility of goods and capital, immobility of H and L ) makes capital move from North to South until its return is identical in both countries. The new equilibrium with North-South openness (free trade and mobile capital) is then characterized by: 1. A transfer of capital from North (where it is initially less paid) to South (where it is initially better paid). This makes part of the capital located in South belong to North capital owners. 2. An equalization of the return to capital at the world level. 3. An increase in the return to capital for the North capital owners. As regards income distribution between skilled workers, unskilled workers and capital owners, the impact of openness depends on the North-South divergence in factor endowments. We know that HN/LN > HS/LS and that KN/(HN + LN) > KS/(HS + LS) (North is relatively better endowed with capital than South), which implies KN/LN > KS/LS. This last feature covers two situations. First, if KN/HN > KS/HS, then capital owners’ income increase more than the incomes of both unskilled and skilled workers. In this configuration, capital owners win against all workers, and skilled workers win against the unskilled. Second, if KN/HN < KS/ HS, capital owners win in relation to the unskilled, but they lose in relation to the skilled. In all cases, both capital owners and skilled workers win against the unskilled who are the ‘big losers’. It must finally be noted that a proportion of the gains of the North capital owners are transferred from South.

2.2

Offshoring and Global Value Chains

Offshoring and the development of global value chains are key characteristics of the present wave of globalization. They consist in relocating the different production stages of goods and services in different countries according to the cost advantage brought by each location. According to Baldwin (2006), offshoring can be defined and modelled in two ways. First, the so-called ‘Mankiw offshoring’ (Mankiw & Swagel, 2006) considers production as a combination of intermediate goods produced in different countries. This typically consists in replacing the production scheme ‘factors → final goods’ by the scheme ‘factors → intermediate goods → final goods’ in trade models. Second, the so-called ‘Grossman-Rossi-Hansberg offshoring’ (Grossmann & Rossi-Hansberg, 2008) focuses on trade of individual tasks.

2.2

Offshoring and Global Value Chains

2.2.1

49

Offshoring in Intermediate Goods

It is quite easy to insert trade of intermediate goods or production stages within an HOS approach. This consists in moving from a 2 × 2 × 2 (2 goods×2 factors ×2 countries) model to a 2 × 2 × 2 × 2 (2 final goods×2 intermediate goods×2 factors×2 countries) framework. Then, final goods are intermediate good-intensive, and intermediate goods are factor-intensive. Obviously, final goods are also indirectly factorintensive through intermediate goods. In what follows, each intermediate good is defined as a production stage. We expand the NS-HOS model by assuming (i) two production stages, one H-intensive denoted as h and one L-intensive denoted as l, and two final goods, one h-intensive and the other l-intensive. As usual, North is highly endowed with skilled labour and South with unskilled labour. A formal presentation of the North-South HOS model with intermediate goods is exposed in Appendix C. The outcomes of this expanded model are to a large extent similar to those of the basic NS-HOS approach. Each country now specializes in the production and export of the stage which is intensive in its abundant factor. Hence, the outcomes in terms of factor prices (wages and skill premium) are identical. The only difference is that, in contrast, with the 2 × 2 × 2 model, NS trade can now increase the skill intensity of both sectors of final goods in North, which is in line with observed facts.15 Within such a framework, the only way to obtain a higher increase in inequality in North is to assume a higher divergence in factor intensities in the final goods production in the model with intermediate goods16 than in the model without.

2.2.2

Offshoring in Individual Tasks

Offshoring in individual tasks allows a far more disaggregated division of labour across countries. The tale behind this approach is the following. Production consists in the combination of individual tasks which can be performed in any country. There is nevertheless an offshoring cost which integrates the organization, transport, control, training, productivity gap, etc. costs linked to offshoring. Then, a task is offshored if its total cost (direct cost + offshoring cost) is lower abroad than in the domestic country. For each task or type of task, firms then select the country where this total cost is the lowest. To understand the logic of offshoring in individual tasks, it can be fruitful to assume a simplistic situation in which (1) there is one homogenous good produced

15 This is because, statistically, (i) the factors accounted in the production of each sector of final goods in North are those imbedded in the stages produced in North and (ii) North is specialized in the H-intensive stage. 16 The factor intensities in the production of final goods are combinations of the factor intensities in stages and of the stage intensities in final goods (see Appendix C).

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with unskilled and skilled tasks, (2) tasks of the same type (skilled/unskilled) are perfectly substitutable, (3) the offshoring cost is nil and (4) North is endowed with both skilled and unskilled labour and South with unskilled workers only. One unit of skilled or unskilled labour accounts for one task of the related type. The advanced technology is that of North and, before openness, South produces using a traditional low-productive technology. The technology being neoclassical, factors are paid at their marginal productivity. We assume that when being in autarky, the fullemployment North unskilled wage is at its reservation level. In South, the wage corresponding to traditional activities is very low so that all workers always prefer to work in Northern firms. We finally assume that the amount of unskilled labour is higher in South than in North. North-South openness makes Northern firms relocate unskilled tasks to South. Consequently, the unskilled wage falls. Since the unskilled labour is larger in South than in North, the unskilled wage corresponding to full employment in South is below the North reservation wage. In this case, all the North unskilled workers are unemployed. This borderline case shows that unlike offshoring of intermediate goods, offshoring in tasks can lead to a complete (or extremely large) decrease in the employment of unskilled workers when all unskilled tasks are offshorable. This is because the production of skill-intensive intermediate goods necessitates a non-nil utilization of unskilled labour, whereas an individual task is either skilled or unskilled. To avoid the disappearing of unskilled jobs, it is then necessary to assume the existence of non-offshorable unskilled tasks. This typically leads to introduce a non-tradable sector when modelling the global economy. Let us now modify the above story by assuming (1) the existence of a non-tradable service sector in North utilizing unskilled labour only, (2) a low reservation wage in North and (3) a globalization process defined as a growing size (population) of South, this area being small at the start of globalization and substantially larger than North at the end. A model of this type is developed in Appendix D. Such a framework generates the following outcomes: 1. In a first phase, the enlargement of South makes a growing share of the unskilled tasks be relocated to this area. The unskilled wage decreases in North, inducing a cut in the cost and price of the non-tradable service and a rise in its demand and production. Hence, the unskilled jobs lost in the sector of tradables are replaced by the creation of jobs in non-tradable services. Finally, this first phase is characterized by an increase in inequality (the skill premium rises) and a decrease in the unskilled real wage in North. 2. When the North unskilled wage and the related price of non-tradable services are sufficiently low to make the production of this sector employ all the North unskilled workers, the North unskilled real wage stops falling, and it rises if the size of South continues to grow. 3. During the first phase, if social policies or labour market rules prevent the downward adjustment of the North unskilled wage, this generates unemployment of unskilled workers in North (as in Davis’ approach, as long as North produces unskilled tasks, the North reservation wage benefits to the South unskilled workers and the so-generated unemployment concentrates in North).

2.2

Offshoring and Global Value Chains

51

4. If we add an offshoring cost, the unskilled wage in South differs from that of North by the amount of this cost. 5. As in the NS-HOS approach, the first phase is characterized by a continuous increase in North workers’ average real wage with winners (skilled workers) and losers (unskilled workers). Hence, a way to make all North workers win consists in transferring a share of the skilled workers’ gains to unskilled workers. A broader approach consists in assuming (i) that the unskilled tasks are imperfectly substitutable, (ii) that they differ in their offshoring costs and (iii) that globalization is now modelled as a decrease in the offshoring cost. The South unskilled wage is assumed exogenously defined by the wage in the traditional (non-modern) sector which no longer exists in North.17 Tasks being ranked by increasing order of offshoring cost, there is a ‘frontier’ task such that its production costs in North and in South are equal. All the tasks below this frontier are produced in South and all those above in North. By lowering the offshoring cost, globalization moves upward the frontier task and increases the number of tasks performed in South. This typically reduces the demand for Northern unskilled workers, lessening their real wage and increasing inequality. When, on top of the sector with offshorable tasks, we add a non-tradable service produced with unskilled labour, this sector slows down the decline in the North unskilled wage and the rise in North inequality. This is because the fall in unskilled wage lessens the non-tradable service price, raising its demand and thereby the demand for unskilled labour. Grossmann and Rossi-Hansberg (2006, 2008) develop an NS-HOS model with offshoring which provides more mixed results since the fall in offshoring cost can lead to a gain for North unskilled workers.18 As above, the offshoring cost differs with tasks. There is (i) a continuum of unskilled tasks i in the interval [0, 1] ranked by increasing order of offshoring cost t(i) and (ii) a set of skilled task performed in North. For any unskilled task, one unit of North labour produces one unit of task. In South, β × t(i) units of labour are necessary to produce one unit of unskilled task i, with ∂t/∂i > 0 and β × t(i) > 1, 8 i 2 [0, 1]. The first feature denotes the ordering of tasks and the second the existence of a non-zero offshoring cost, and the parameter β decreases with time so as to portray the globalization dynamics. Denoting wNL and wSL the unskilled wage in North and South, respectively, there is a frontier task f such that wNL = β × t ðf Þ × wSL , and all the tasks below this frontier are produced in South and all those above in North. Within this framework, Grossmann and Rossi-Hansberg (2008) show that a decrease in the offshoring cost has three effects in terms of demand and wage of unskilled workers: 1. The cost of unskilled tasks decreases, which raises its demand and thereby the unskilled wage. This channel is called ‘productivity effect’ because it is equivalent to an increase in unskilled labour productivity in the production of tasks.

17 This is only true as long as this traditional sector exists in South, i.e. as long as the whole of the South unskilled workers is not employed in the modern sector (i.e. in offshored tasks). 18 In what follows, we expose a very simplified presentation of G&R-H rationale.

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2. The decrease in the relative price of the unskilled-intensive good reduces the wage of unskilled workers through the Stolper-Samuelson mechanism (the ‘relative-price effect’). 3. The decrease in offshoring cost increases the number of offshored tasks and lessens the utilization and wage of domestic unskilled labour. The authors then show that in the case of a small advanced country, the benefits from a reduction in the offshoring cost (decrease in β) are fully captured by unskilled workers. This reduction entails (i) a lower demand for unskilled labour, because some tasks previously performed in the country are offshored, and (ii) an expansion of the unskilled-intensive industry which primarily benefits from the cut in cost. This second effect more than offsets the first.

2.3

Trade and Technology Interplay

In Sect. 2.1, we have introduced technological change as a source of inequality. This channel has been abundantly analysed in the literature, and a large number of theoretical and empirical works have presented skill-biased technological change and North-South trade (or globalization) as alternative explanations for the rise in inequality. This opposition between the two explanations is to a large extent inadequate because both factors interact and tend to reinforce each other. An example of this interplay has already been exposed in Sect. 2.1.3 when analysing technological differences and transfers between North and South. We have noticed that when South suffers an initial productivity gap and if globalization comes with productivity catching up, this typically acts as an increase in the size of South and leads to a lasting increase in the skill premium and inequality in North. In this section, we examine several channels in which trade and technology interact and generate inequality.

2.3.1

Capital-Skill Complementarity

Following the pioneering work of Griliches (1969) who found evidence from US manufacturing that capital and skilled labour are more complementary than capital and unskilled labour, a large number of studies have investigated the capital-skill complementarity (CSC) hypothesis. Those works tend to rather support CSC (see, for example, Hamermesh, 1993; Duffy et al., 2004). This hypothesis has subsequently been utilized to explain rising inequality between skilled and unskilled workers (Krusell et al., 2000). Consider a technology (production function) which utilizes three factors, unskilled labour L, skilled labour H and capital K, and assume that K and L are substitutes, whereas K and H are complements. Suppose now a decrease in the price

2.3

Trade and Technology Interplay

53

of capital. This entails an increase in the capital used in production. As K and L are substitutes, the demand for L decreases, whereas the K-H complementarity increases the demand for H. In consequence, the relative demand H/L and the skill premium move upward. Increases in the relative demand H/L and in the skill premium also occur, but with a lower intensity, if both skilled and unskilled labours are substitutes for capital with L being more substitutable for K than H. Globalization induces a large offshoring to the South of tasks in the production of capital, as this has been observed for computers, electronic components, communication instruments, etc. This typically lessens the cost and price of capital. Then, capital-skill complementarity (or lower substitutability between K and H than between K and L ) leads to an increase in the skill premium and inequality through the above-exposed mechanism. In this story, globalization acts by lessening the price of capital, and technology raises the demand for skill and the skill premium through capital-skill complementarity. Several works utilizing different methods for different countries have confirmed the impact of capital-skill complementarity on inequality (e.g. Lindquist, 2005, for Sweden and Winchester & Greenaway, 2007, by simulating a CGE model, for the UK).

2.3.2

Property Rights Enforcement and Globalization-Driven-Biased Technical Change

Acemoglu (1998, 2003a, b) has highlighted several channels through which globalization can impact technical change and thereby inequality. Those analyses are based on his approach of ‘directed technological change’ (DTC). DTC refers to situations in which the firms’ technological strategy is biased in favour of a factor, this bias being typically explained by a change in factor costs. Normally, the decrease in the cost of unskilled labour linked to the insertion of emerging countries into the globalized economy should both relocated some production stages in the South and foster a technological change directed towards unskilled labour. Nevertheless, when property rights are poorly enforced in emerging countries, Northern firms have an incentive to promote pro-skill technologies which cannot be copied by those countries’ firms. The related skill-biased technological change (SBTC) raises inequality. Presented by Acemoglu (1998) and Thoenig and Verdier (2003), this explanation gives a sound basis to the hypothesis of ‘defensive technological change’ initially presented by Wood (1994). This hypothesis states that northern countries protect themselves from the South competition by setting SBTC strategies. This explanation was criticized because firm should rather benefit from the low labour cost by relocating their production to the South. The weak enforcement of property rights in the South then provides a rigorous explanation for the defensive technological change hypothesis.

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Another mechanism is presented by Acemoglu (2003a). By increasing the price of skill-intensive goods, North-South trade fosters R&D in those sectors entailing a growing demand for skilled labour and an increase in the skill premium. Finally, NST and SBTC can be combined with labour market institutions to explain divergences between Europe and the USA. If labour market institutions generate wage compression in Europe and not in the USA, this fosters investments in technologies increasing the productivity of less-skilled workers in Europe, entailing less skill-biased technical change in Europe than in the USA (Acemoglu, 2003b).

2.4

Polarization

All the explanations exposed until now were based on a simple division between skilled and unskilled labour. Since earnings positively depend on skill, this division can be seen as acceptable as long as inequality takes the shape of earnings relative gains which increase with the earnings level. But we have observed for two decades a new shape in which the main losers have been at the middle of the income and skill spectrum, the bottom benefiting from a limited increase and the top showing a large increase. The same shape has concurrently been observed for job creation. To analyse this ‘polarization’ profile, it is necessary to assume at least three types of labour: low skilled L, medium skilled M and high skilled H.19 In line with the analyses of inequality, three usual suspects have been considered to explain polarization, namely, technological change, institutional changes and globalization (essentially NST). The technological explanation is the most achieved because it provides a general framework which explains the variations in income distribution since World War II (WW2) characterized successively by equality, inequality and polarization. Based on the works of Acemoglu (1998, 2002), Autor et al. (2003, 2006), Goldin and Katz (2009) and Acemoglu and Autor (2011), this general explanation combines (i) skillbiased-directed technical change and (ii) automation generating task-biased technical change. This story can be presented as follows: The democratization of education implemented after WW2 increased the skill level of the population, lessening the skill premium and favouring equality (stage 1). The decreasing skill premium encouraged firms to implement R&D in the skillintensive sector of intermediate goods, increasing skilled labour productivity, the demand for skill and finally the skill premium (Acemoglu, 1998; stage 2). In this sequence, skill upgrading due to education firstly boosted equality through the supply effect and subsequently increased inequality through directed technical change which augmented the demand for skilled workers. Following this line,

19

It is also possible to assume a continuum of skills (human capital) in an interval and to analyse what occurs at the bottom, the middle and the top of this interval.

2.4

Polarization

55

Goldin and Katz, (2007, 2009) have diagnosed a race between education and technology which generates oscillations in income distribution. In a third stage, polarization derives from computerization and automation which have reduced a number of middle-skilled tasks in manufacturing (skilled blue collars) and in services. This mechanism defines the task-biased technical change (TBTC) hypothesis. In a first set of works, Autor et al. (2003, 2006) distinguished routine from non-routine tasks and assumed a high substitutability between the former and computer capital. Technological change then lowers the cost of capital and lessens thereby the demand and pay for routine tasks and jobs, but not for manual occupations which are not substitutes for computer capital. Acemoglu and Autor (2011) developed a synthetic model of TBTC which generates polarization, i.e. an increase in the wage of high-skilled relative to medium-skilled workers and a decrease in the wage of medium- relative to low-skilled workers. In this model, production combines a continuum of tasks, and two thresholds are endogenously determined. The tasks below the first threshold are performed by unskilled workers, the tasks above the second by high-skilled workers and the tasks in between by medium-skilled workers. Task-biased technological change displaces these thresholds and generates polarization, i.e. capital substitutes for medium-skilled workers. Several empirical works confirm the technological explanation for polarization (Autor et al., 2003, 2006; Autor & Dorn 2013; Feng & Graetz, 2015; Goos et al., 2014; Michaels et al. 2014; Böckerman et al., 2019). By combining the changes in inequality based on directed technological change (Acemoglu, 1998) with TBTC-based polarization (Acemoglu & Autor, 2011), we obtain a unified technological approach of the three phases of income distribution since World War II. The impact of institutions on polarization remains controversial. Two major institutional factors have been pointed out. First, de-unionization has particularly hurt medium-skilled workers because these constituted a large part of the unions’ members. However, the causality is ambiguous because (i) the decline in mediumskilled workers, particularly in the number of professional blue collars, is considered as a major reason for the decline in unionization and (ii) de-unionization is also often linked to technical change and globalization, which would thereby make these changes to be the ultimate explanations. The impact of globalization on unionization is discussed in Chap. 4. Another institutional explanation for polarization is the setting and variation in minimum wages. In the case of the USA, it has nevertheless been stressed that the timing of the variations in the minimum wage is not consistent with this explanation (Autor, 2010). As for inequality, the third explanation for polarization is based on globalization, and North-South trade with differences in factor endowments is the core of this explanation.

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2.4.1

2

Trade and Inequality

Skill Upgrading in Emerging Countries and Polarization

In the last decades, most Asian emerging countries have followed education and skill upgrading policies. This is in particular the case of China since the 1990s. Consider once again a North-South trade model and assume three factors of production, low-, medium- and high-skilled labour. As in the NS-HOS model, free trade results in factor price equalization. If the educational policies of emerging countries modify their skill structure by lessening the proportion of less skilled and increasing the proportion of medium-skilled, then the unskilled wage tends to get over, and the medium-skilled wage declines. Now, if labour market imperfections had resulted in unskilled unemployment in the North, this variation in the South endowment reduces both the North unskilled unemployment and the North medium wage. Those variations draw polarization profiles in wages and jobs. Another explanation can be given by extending the substitution of capital for medium skills as presented by Autor et al. (2003, 2006) in their analysis of TBTC. If globalization reduces the price of computer capital by relocating to the South the low- and medium-skilled tasks, the related rise in capital utilization lowers the demand for and the wage of medium-skilled workers performing routine tasks. This generates polarization. In this vein, Acemoglu and Autor (2011) show that offshoring leads to the same variation in earnings as task-biased technical change. Goos et al. (2014) develop a model in which output is produced out of tasks combining occupations and another factor and show that both routine-biased technological change and offshoring lead to job polarization. Finally, several works provide evidence of the pro-polarization effect of offshoring (Oldenski, 2014; Keller & Utar, 2016; Lewandowski et al., 2022).

2.4.2

Globalization-Induced Education Decisions and Polarization

The previous explanations were based on an exogenous increase in the mediumskilled endowment of emerging countries. Several models have endogenized the education decisions of individuals so as to generate polarization of employment and/or incomes. For offshoring of the medium skill-intensive goods and tasks to occur, a sufficient amount of medium-skilled workers should be available in the South. Moreover, a lower demand for medium-skilled workers in the North can be offset by a lower supply. Hence, an assessment of the impact of North-South trade and offshoring upon polarization should consider the influence of North-South globalization on the skill dynamics and educational decisions in the North. If trade liberalization results in a North-South competition in the provision of middle-skilled tasks and if it is more costly to attend higher education in emerging

2.4

Polarization

57

countries compared to advanced countries, there will be a disproportionately large amount of individuals with high ability who will select middle skill rather than higher skill in emerging countries. This can generate an educational polarization in advanced countries in which a larger proportion of the least able will remain unskilled and a larger part of the most able will attend higher education. Of course, those moves crucially depend on the country’s educational structure (Blanchard & Willmann, 2016). Another way to generate polarization in advanced economies consists in augmenting their share of medium-skilled workers and to lessen concurrently the share of the less skilled. Assume a technology which utilizes low-skilled L, medium-skilled M and highskilled H labour. North-South openness occurs as the South is endowed with low-skilled labour only. Then, Northern firms offshore some of the unskilled tasks (those with a sufficiently low offshoring cost), and the decrease in offshoring costs entails that a growing share of unskilled tasks are relocated in the South, which reduces the unskilled wage and rises the wage of both the medium- and high-skilled in relation to low-skilled workers in North. This incites the children from low-skilled families to increase their skill and invest in education. The next generation is then characterized by a reduction in the supply of low-skilled labour and an increase in the supply of medium-skilled, which in turn tend to increase the low-skilled wages and reduce the middle-skilled wages (Hellier, 2016).

2.4.3

Empirical Evidence

Finally, a number of empirical works suggest that trade has had a non-negligible role in the decline of the middle-class routine jobs and wages: Goos and Manning (2007) for the UK; Becker et al. (2009) for Germany; Autor et al. (2003, 2006), Oldenski (2014) and Cavenaile (2021)20 for the USA; Goos et al. (2014) for Western European countries; Keller and Utar (2016) for Denmark; Kerr et al. (2016) for Finland; Harrigan et al. (2016) for France; and Gravina and Foster-McGregor (2020) for 18 advanced European economies. Lewandowski et al. (2022) find that globalization reduces routine task intensity in richer countries and increases it in poorer countries.

Cavenaile (2021) finds that computerization is the main driver of polarization in the USA from 1975 to the mid-1990s, whereas offshoring explains more than 70% of wage and job polarization from the mid-1990s to 2008. 20

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2.5

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Trade and Inequality

Globalization and the Superstars

The huge increase in the income and wealth of the richest (top 0.1%, top 0.01%) over the last three decades is now abundantly documented. The earnings of top managers and top performers (actresses, actors, singers, athletes, etc.) have known an impressive upsurge. This has motivated a large literature on the analysis of ‘superstars’, i.e. persons belonging to the top in terms of earnings and talent.21 Rosen (1981) was the first to propose an explanation for the ‘overpaying’ of top managers, his model being also applicable to top performers (singers, actresses/ actors, athletes, etc.). He assumes that managers differ in talent and finds that the differences in talent are magnified when considering wages because (1) the talents are poorly substitutable and (2) production costs increase less than proportionally with sales. Differences in talents are also assumed by MacDonald (1988) who adds a dynamic knowledge process and by Borghans and Groot (1998) who add a monopoly power of the superstars, both approaches resulting in superstars’ overpayment. Such overpayment can also be found without differences in talent (Adler, 1985; Chung & Cox, 1994; Borghans & Groot, 1998). The huge increase in managers’ earnings has incited economists to present additional explanations such as a growing demand for general managerial skills at the expense of firm-specific skills (Murphy & Zabojnik, 2007; Frydman, 2019), the firms’ size (Gabaix & Landier, 2008) and an increase in wage competition between managers (Subramanian, 2013). Four major mechanisms make globalization to raise the managers’ income: (1) the increase in the market size, (2) a larger size of firms, (3) the emergence of a global market for managers and (4) the increase in capital utilization when capital and managerial skills are complementary. Based on the first three factors and on a definition of globalization which combines the integrations of both product markets and managerial pools, Gersbach and Schmutzler (2014) generate heterogeneity in managerial earnings and a rise in top executives’ wages. Capital-talent complementarity is the central explanation in Haskel et al. (2012). Their model does not apply to the sole top managers but also and perhaps primarily to actresses, actors and singers. The authors present an extended HOS approach with workers differing in talent and talent-capital complementarity in one sector but not in the other (in this second sector, talent has no impact on labour productivity). An increase in capital productivity then increases both the return to capital and the wages of the most talented workers because of capital-talent complementarity, and it lessens the wage of the less talented. Correa et al. (2022) provide empirical evidence of the pro-inequality impact of trade on the CEO incomes for the US. If the increase in earnings of top performers (actresses and actors, singers, TV shows and programmes producers, high-level athletes, etc.) is now well documented,22 the globalization-driven theoretical explanations for this critical rise 21 The term ‘superstar’ is also utilized for firms, sectors and cities (general presentation in Manyika et al., 2018). 22 See the examples given by Bourguignon (2012, pp.42–43).

2.6

Empirical Evidence on Trade and Inequality

59

remain limited. Of course, the emergence of a large globalized market is a key element, but this market expansion could just diversify the number of consumed performances in all countries without generating an overpayment of the most talented. Hellier (2023a) proposes a model of asymmetric globalization which generates a large overpayment of the performers belonging to the culturally dominant country(ies). This approach compares symmetric globalization, in which the performers’ talent is the same in the global economy and in their home country, and asymmetric globalization characterized by one (or a limited number of) country(ies) producing globalized performances, whereas others produce purely national ones. With symmetric globalization, the performers’ earnings are not modified because the market enlargement is offset by the decrease in per-performance expenditure. In contrast, asymmetric globalization generates a substantial overpayment of performers in countries benefiting from cultural supremacy and a reduction in the earnings of purely national performers, leading to a significant increase in inequality among performers at the world level.

2.6

Empirical Evidence on Trade and Inequality

The impact of trade on inequality in advanced economies has given rise to an abundant empirical literature since the early 1990s. The number of works is so large that a general survey of this literature would require at least one full chapter. Several empirical methods have been utilized, and all of them suffer limits and shortcomings (see, the discussions in Chusseau et al., 2008, and Chusseau and Dumont, 2013). The results of this literature are very diverse depending on the periods of study, on the methods and on the investigated country(ies) and sector(s). We thus refer to the numerous surveys on the subject,23 and this section is restricted to the general diagnosis that can be made from this literature. First, two periods can be distinguished in the empirical literature which has attempted to measure the impact of trade on inequality (Chusseau et al., 2008, Chusseau & Dumont, 2013). A first strand of empirical works realized in the 1990s with data essentially covering the 1970s, 1980s and early 1990s diagnosed a very limited impact of trade. Those works can be seen as inadequate to account for the present wave of globalization because (i) most of the data concern periods in which emerging countries, particularly China, were not major exporters (Krugman, 2008) and (ii) a large part of the studies put together North-North trade and NorthSouth trade, whereas only the latter has a clear impact on growing inequality. In contrast, the empirical studies realized from the late 1990s typically reveal a

23

For early surveys: Bound and Johnson (1992), Levy and Murname (1992), Freeman (1995), Richardson (1995), Slaughter (1999), Desjonqueres et al. (1999), Singh and Dhumale (2004). More recent surveys: Chusseau et al. (2008), Chusseau and Hellier (2012), Chusseau and Dumont (2013), Kurokawa (2014), Bourguignon (2016), Helpman (2017), Ravallion (2018), Heimberger (2020).

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non-negligible impact of trade with emerging countries upon inequality and employment in advanced economies. However, the strength of this impact can significantly differ across countries, sectors and periods. Second, if technological changes and for some countries (the UK, the USA) labour market institutional changes were major determinants of rising inequality in the 1980s and early 1990s, the impact of trade with emerging countries has become a key factor since the late 1990s. For the USA, the existence of two different periods in the explanation for rising inequality, technological change being the major driver before the 1990s and import competition from emerging countries after, is confirmed by Rigby et al. (2015). Third, offshoring seems to be the major vector of the trade-induced increase in inequality and decrease in low- and middle-skilled workers’ employment. This result, already highlighted by Bottini et al. (2008) and Crino (2009) in their review articles, is confirmed by a number of more recent works (Kemeny and Rigby, 2012, and Cavenaile, 2021, for the USA; Koerner et al., 2022, for Germany; Broccolini et al., 2011, for Italy, etc.).

2.7

Major Lessons on Trade and Inequality

We have presented several channels through which international trade in goods and services influence inequality: North-South trade of final goods, of intermediate goods and of tasks (offshoring), interplay between trade and technology, impact of openness on superstars’ income, etc. The different dimensions of North-South trade are clearly the key drivers of this influence. By focusing on the different channels binding NST and inequality, we can state the following diagnosis: 1. Both trade of final goods and offshoring between advanced and emerging countries generate winners (high-skilled workers and capital owners) and losers (low-skilled and medium-skilled workers) in advanced economies. Hence, NST increases inequality in those countries. 2. Both the growing size of the South and its catching up in productivity enlarge the winners’ gain and the losers’ pain, increasing thereby inequality in the North. 3. If labour market imperfections and/or institutions prevent the unskilled workers’ wage downward adjustment, this generates unemployment of the less skilled. 4. Despite the existence of winners and losers, North-South trade increases the average real income per capita in advanced economies when wage adjustment ensures full employment. In this case, North workers win on average. 5. Finally, since there are winners and losers with the North workers benefiting on average of North-South openness, a simple way to make all North workers win (or at least no one lose) consists in transferring a share of the winners’ gains to the losers, i.e. redistribution. This would make NST an optimal situation, Pareto superior to any situation with trade barriers between the North and the South.

Appendices

61

Of course, this solution is conditioned by the feasibility of redistribution between the winners and the losers. We show in the next chapter that the mobility of tax bases, which is on top of North-South trade and offshoring another key element of globalization, impedes to a large extent the setting of this solution.

Appendices Appendix A: The Basic North-South HOS Model The world economy is composed of two countries, North (N ) and South (S); two factors, high-skilled labour H and low-skilled labour L; and two final goods, one skill-intensive (good h) and the other unskilled-intensive (good l). We assume that: 1. All markets (for factors and goods) are perfectly competitive. 2. In all countries, households supply one unit of their type of labour and have the same instantaneous utility function: U = β log cl þ ð1 - βÞ log ch , where ci, i = h, l, is the consumption if good i. 3. The technologies are Cobb-Douglas and identical in both countries: Y h = Ah Lh αh H h 1 - αh for good h, Y l = Al Ll αl H l 1 - αl for good l, with αh < αl, which indicates that good h is H-intensive and good l is L-intensive. 4. The North is relatively better endowed with skilled labour and the South with unskilled labour: H L L HN > S, S > N, LN LS HS HN where H j and Lj are, respectively, the skilled labour and unskilled labour endowments in country j = N, S. We successively study the equilibrium in autarky and in free trade.

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Autarky Consider country j = N, S. The maximization of utility subject to the income constraint determines the macro-demand for each good Y di,j , i = h,l, in relation to total income wjL Lj þ wjH H j , wjL and wjH being, respectively, the nominal wage of unskilled and skilled workers in country j. In each sector i = h,l, the maximization of the firm’s profit subject to the technological constraint (production function) determines the total demand for each factor Lji and H ji in relation to the sector’s production (supply) Y si,j . Considering the equilibrium in country j’s labour markets Lj = Ljh þ Ljl and H j = H jh þ H jl , this yields the following skill premium (ratio of the skilled workers’ wage to the unskilled workers’ wage) which measures inequality: ωj 

wjH 1 - α Lj = , j = N, S α Hj wjL

ð2:A1Þ

with α = βαl + (1 - β)αh. Relation (2.A1) shows that in autarky inequality is higher in South than in North LS =H S > LN =H N ) ωS > ωN . The general equilibrium of the model also determines the factor intensity in each Lj

pj

i

l

sector and each country Hij , the ratio of prices phj in each country, the consumer price index pj = plj wjL

pj ,

β

phj

1-β

and the real wage of skilled and unskilled workers,

wjH pj

and

in each country: Lji αi ð1 - αÞ Lj αi = ω , i = h, l, j = N, S: j = ð1 - α Þα 1 αi j Hj i Hi 1 - αl Al αl αl ð1 - αl Þ = Ah αh αh ð1 - αh Þ1 - αh plj

phj

pj =

wHj wLj

αl - αh

ð2:A3Þ

ωj 1 - α wLj β

Al β Ah 1 - β αl αl ð1 - αl Þ1 - αl

wLj = Al β Ah 1 - β αl αl ð1 - αl Þ1 - αl pj

β

wHj = Al β Ah 1 - β αl αl ð1 - αl Þ1 - αl pj

αh αh ð1 - αh Þ1 - αh

αh αh ð1 - αh Þ1 - αh β

ð2:A2Þ

1-β

αh αh ð1 - αh Þ1 - αh

1-β

ð2:A4Þ

ωj - ð1 - αÞ

ð2:A5Þ

1-β

ωj α

ð2:A6Þ

Appendices

63

North-South Openness The only assumption which distinguishes North-South free trade from the setting of an integrated world economy is the between-country immobility of factors. Consequently, we can firstly treat North-South openness as the formation of an integrated global economy and verify afterwards if the so-determined equilibrium is consistent with factor immobility.

The Integrated Global Economy Determining the equilibrium corresponding to an integrated global economy leads to the same results as those described by relations (2.A1)–(2.A6), but with a world factor endowment being the sum of those of North and South. With G denoting the global economy, we can thus write LG = LN þ LS and H G = H N þ H S . Since LS =H S > LN =H N , then: LS L L > G > N HS HG HN

ð2:A7Þ

And: wG 1 - α LG H = α HG wG L

ð2:A8Þ

HG 1 - αi i ωG - 1 , i = h, l: G = αi Li

ð2:A9Þ

ωG  ηG i 

1 - αl pG Al αl αl ð1 - αl Þ h ωG α l - α h G = A α αh pl h h ð1 - αh Þ1 - αh

pG =

ð2:A10Þ

ωG 1 - α wG L Al β Ah 1 - β αl αl ð1 - αl Þ1 - αl

wG L = Al β Ah 1 - β αl αl ð1 - αl Þ1 - αl pG

β

wG H = Al β Ah 1 - β αl αl ð1 - αl Þ1 - αl pG

β

αh αh ð1 - αh Þ1 - αh

α h α h ð 1 - αh Þ 1 - α h β

1-β

αh αh ð1 - αh Þ1 - αh

1-β

ωG - ð1 - αÞ

1-β

ωG α

ð2:A11Þ

ð2:A12Þ ð2:A13Þ

Suppose that the above values are consistent with the factor immobility constraint. Since those values are determined at the global level, both countries’ factor price equalization is straightforward. Combining (2.A7) and (2.A8) shows that free trade makes the skill premium increase in North and decrease in South:

64

2

ω N < ωG < ωS

Trade and Inequality

ð2:A14Þ

Combining (2.A12) and (2.A14) shows that the real wage of unskilled workers decreases and combining (2.A13) and (2.A14) that the real wage of skilled workers increases in North.

The Diversification Cone Let us now introduce the factor immobility constraint. The integrated global equilibrium fully defines the skill premium ωG (relation 2.A8), and this skill premium G determines the skill intensities in sectors h and l, ηG h and ηl (relation 2.A9). As G G utilised skilled labour ηh > ηl , the highest possible relative utilization of skilled labour (utilised unskilled labour) G is ηh (corresponding to the production of the sole good h), and the lowest is ηG l (corresponding to the production of the sole good l). As labour markets are competitive, the factor prices adjust supply and demand, and unemployment is impossible in both labour markets and both countries. This means that for the skill premium ωW, both countries’ skill relative endowments must stand between ηW l HS HN W W and ηW : η ≤ < ≤ η . Otherwise, both factors would not be fully utilized h l h L L S

N

everywhere, which is impossible given the competitive market hypothesis. This can be represented in the map (L,H) by drawing the cone formed by the lines H = ηW l ×L × L, called diversification cone (see Fig. 2.1 in the text). The countries’ and H = ηW h factor endowments LS , H S and LN , H N must then be located inside the cone. What happens if one (or two) countries are outside the diversification cone? Let us take the example of the South being outside the cone, whereas the North is inside. This means that there would be unemployment of the unskilled for the world equilibrium value of the skill premium ωW. Then, market clearing imposes a lower South skill premium ωS so as to reach full employment. But then, both countries cannot produce both goods because this would violate the law of one price which is always fulfilled with homogenous goods in free trade. As it is the South which is outside the cone,24 the South produces good l only and the North both goods, the law of one price for good l being enforced by the exchange rate adjustment between the two countries’ currencies.

24

This corresponds to the South being small compared to the North because the North is inside the world cone and not the South, which means that the world cone is not too different from the North cone in autarky but significantly different from the South cone in autarky.

Appendices

65

Appendix B: The NS-HOS Model with Fair Wage Assume an NS-HOS framework as in Appendix A which is modified by assuming that the North unskilled labour market is characterized by a fair wage behaviour of the workers. Hence, the efficient unskilled labour is equal to the labour time L multiplied by the workers effort E. The unskilled workers’ effort function is: E ðωÞ = 2 - ð1 - uL Þω=ωf

ð2:B1Þ

where ω = wH/wL is the skill premium, ωf the ‘fair’ skill premium and uL the North rate of unskilled unemployment. The unskilled workers’ effort depends (i) on the skill premium, i.e. on the difference between the high wages (paid to skilled workers) and the unskilled wage, and (ii) on the unemployment rate of unskilled workers uL. The effort is 1 when the skill premium is equal to ωf and when the unemployment of the unskilled is nil. When the skill premium is unfair (ω > ωf), the worker reduces her/his effort, but this reduction is moderated by the level of unemployment in the unskilled labour market. In sector i = h,l, North firms maximize their profit π i = piYi - wHHi - wLLi such that Y i = Ai ðH i Þ1 - αj ðE × Li Þαj and E(ω) = 2 - (1 - uL)ω/ωf.25 This determines the following values at the firms’ optimum:26 ωf 1 - uL w = ð1 - uL Þ H ωf

ωeff = weff L

ð2:B2Þ ð2:B3Þ

E=1

ð2:B4Þ

eff The efficiency unskilled wage weff L (Eq. 2.B3) and efficiency skill premium ω (Eq. 2.B2) are identical for all firms whatever their sector. We suppose that the equilibrium skill premium and the efficiency skill premium are similar when being in autarky, and we analyse the impact of North-South openness within the NS-HOS framework defined in Appendix A. Several cases

25

For the sake of simplicity, subscripts and superscripts indicating the North do not appear.

26

π i = pi Ai ðH i Þ1 - αi 2 - ð1 - uL ÞwH =ωf wL

αi

ðLi Þαi - wH H i - wL Li

∂π i =∂Li = 0 ) αi pi Y i =Li = wL

ωf - 1 wL ð1 - uL Þω w ) E = 1 and wL = ð1 - uL Þ H ωf

∂π i =∂wL = 0 ) αi pi Y i =Li = 2

) ω=

ωf 1 - uL

66

2

Trade and Inequality

can then be distinguished according to whether North and South produce both goods or not.

North and South Produce Both Goods We are then in a Davis-type approach (Davis, 1998a). North-South openness should normally make the skill premium increase in North, but the North firms oppose this move by enforcing the efficiency unskilled wage and skill premium, and the South ‘adopts’ the North skill premium through the mechanism exposed in Sect. 2.1.4.2. This generates unemployment at the world level, and all the so-generated unemployment is located in North. To determine the North unskilled unemployment rate, it is sufficient to modify Eq. (2.A8) by replacing ωG by ωeffand by endogenizing the unskilled wage utilization: LG =

α L - LG ωeff H G and uL = G 1-α LN

North Produces Both Goods and South Good l Only The North skill premium has the efficiency value wNH =wNL = ωeff defined by Eq. 2.B2. Market clearing (supply = demand) in the world markets for goods can be written: ph Y Nh = ð1 - βÞ pl Y Sl þ wL LN þ wH H N

ð2:B5Þ

pl Y Nl þ pl Y Sl = β pl Y Sl þ wL LN þ wH H N

ð2:B6Þ

North produces both goods. Hence, because of the Cobb-Douglas technology: wNL LNl = pl Y Nl ; αl

wNL LNh = ph Y Nh αh

ð2:B7Þ

And: pl =

ωeff

1 - αl

Al αl αl ð1 - αl Þ1 - αl

Combining Eqs. 2.B5 to 2.B8 yields:

wNL

ð2:B8Þ

Appendices

67 1-α

l ωeff α α -α L - LN LN = Y S , and uL = N ωeff H N - l 1 1 - α Al αl αl ð1 - αl Þ - αl l 1-α LN

α

with Y Sl = Al LS l H S

1 - αl

w and α = βαl + (1 - β)αh.

North Produces Good h Only When North produce good h only, the Cobb-Douglas technology determines the unskilled labour utilization for the efficiency skill premium LN = 1 -αhαh ωeff H N ,

which determines the North unskilled unemployment rate uL =

LN - LN . LN

Appendix C: The NS-HOS Model with Offshoring We assume a 2 × 2 × 2 × 2 HOS-type model with two countries (North and South), two factors (skilled labour H and unskilled labour L ), two intermediate goods (l which is L-intensive and h which is H-intensive) and two final goods (l’ which is l-intensive and h’ which is h-intensive). As usual, North is relatively better endowed with skilled labour. The production functions of intermediate and final goods are: Y l = Ll αl H l 1 - αl , Y h = Lh αh H h 1 - αh Y l ′ = ðY ll0 Þαl0 ðY hl0 Þ1 - αl0

Y h ′ = ðY lh0 Þαh0 ðY hh0 Þ1 - αh0

with Hi and Li the quantity of skilled and unskilled labour utilized in the production of intermediate good i = h,l, and Yii′ the quantity of intermediate good i utilized in the production of final good i’ = h’, l’. Because of the skill and intermediate good intensities, we have: αl > αh and αl0 > αh0 We can rewrite the Yii′s production functions as: Y ll ′ = Lll0 αl H ll0 1 - αl Y hl ′ = Lhl0 αh H hl0 1 - αh

Y lh0 = Llh0 αl H lh0 1 - αl Y hh ′ = Lhh0 αh H hh0 1 - αh

where Hii′and Lii′are, respectively, the quantity of skilled and unskilled labour utilized in the production of Yii′.

68

2

Trade and Inequality

Because of the nested Cobb-Douglas production functions, the final goods production functions can be written:27 Y l ′ = Al ′ ðLl0 Þδ ðH l0 Þ1 - δ Y h ′ = Ah ′ ðLh0 Þη ðH h0 Þ1 - η with: Ll ′ = Lll ′ þ Lhl ′

Lh ′ = Llh ′ þ Lhh ′

H l ′ = H ll ′ þ H hl ′ δ = αl αl0 þ αh ð1 - αl0 Þ Al ′ =

Ah ′ =

αl0 αl αl ð1 - αl Þ1 - αl

α l0

H h ′ = H lh ′ þ H hh ′ η = αl αh0 þ αh ð1 - αh0 Þ ð1 - αl0 Þαh αh ð1 - αh Þ1 - αh

1 - αl0

δδ ð1 - δÞ1 - δ αh 0 α l α l ð 1 - α l Þ 1 - α l

α h0

ð1 - αh0 Þαh αh ð1 - αh Þ1 - αh

1 - α h0

ηη ð1 - ηÞ1 - η

It can be easily verified that δ > η Hence, the model provides the same factor prices as a 2 × 2 × 2 model with the final goods displaying the production functions Yl′ = Al′(Ll′)δ(Hl′)1-δ and Yh′ = Ah′(Lh′)η(Hh′)1-η.

Appendix D: A Basic Model with Offshoring in Tasks Consider a global economy with (i) two products, one tradable manufactured good M and one non-tradable service NT; (ii) two factors, high-skilled labour H and low-skilled labour L; and (iii) two countries, North (N ) and South (S), North being endowed with both factors and South with L only. β is the proportion of income consumed in tradable goods and (1-β) the proportion consumed in non-tradable service, and each worker supplies one unit of her/his type of labour (log-linear utility function). The non-tradable service is produced from unskilled labour with a basic one-toone Leontief technology Y iNT = LiNT , i = N, S (superscripts indicate the country and subscripts the sector). In the production of the tradable good M, there is a continuum of perfectly substitutable unskilled task with one unit of each task being produced by one unit

27

Proof available from the author upon request.

Appendices

69

of unskilled labour. Good M is produced at the global level by North multinationals with the North Cobb-Douglas technology YM = A(LM)α(HM)1-α, where LM is the set of unskilled tasks, and hence unskilled labour, utilized in the production of M. Offshoring an unskilled task to South induces an offshoring cost which is modelled by an ‘iceberg’ process: when a task is offshored, a proportion σ of the related labour is lost for production. The productivity of unskilled labour is lower in South than in North, one unit of LS being equivalent to λ < 1 unit of LN . Both markets for M and NT are perfectly competitive. Globalization combines three characteristics: 1. A decrease in the offshoring costσ. 2. A catching up of North productivity by South, i.e. a rise in λ which tends towards 1. 3. An increase in the size of South (number of unskilled workers LS), which depicts the growing amount of developing countries and regions participating in the global economy. Skill-biased technological change (SBTC) is depicted by a decrease in α in the production function. S When all labour markets (LN , H N , L ) are competitive, full employment is achieved in each of them. Then, two cases can be considered: (1) both North and South unskilled workers are employed in the production of the tradable good M, and (2) all unskilled tasks in sector M are produced in South.

Unskilled Tasks Are Produced in Both Areas The North Skill Premium The North skill premium ωN = wNH =wNL is:28 ωN = ∂ωN ∂λ

∂ωN N N > 0; ∂ω < 0; ∂ω ∂σ ∂α ∂LM S M LS ; decrease in σ) and

> 0;

in λ and premium.

ð1 - αÞβ LN þ λð1 - σ ÞLM S HN 1 - ð1 - αÞβ

ð2:D1Þ

< 0: the three components of globalization (rise skill-biased technical change increase the skill

28 This relation is obtained by combining (i) the fact that the share β of the North total income is 1-α NT S N α and allocated to the consumption of NT, (ii) Y NT N = LN , (iii) Y M = A LM þ LM H N N N N (iv) LNT þ LM = L .

70

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Trade and Inequality

Prices Because of the Cobb-Douglas technology, the price of good M is α 1-α pM = A - 1 wNL =α wNH =ð1 - αÞ , and since ωN = wNH =wNL : pM =

ωN 1 - α α Aα ð1 - αÞ1 - α

wNL =

ωN - α α Aα ð1 - αÞ1 - α

wNH

ð2:D2Þ

The technology in the non-tradable sector and the zero profit condition entail: pNNT = wNL The utility function defines the North consumer price pN = ðpM Þβ pNNT Hence: pN = ðpM Þβ wNL

1-β

1-β

.

ð2:D3Þ

Real Wages By inserting (2.D1)–(2.D3) in the North real unskilled and skilled wages ϖ NL  wNL =pN and ϖ NH  wNH =pN , we obtain: ϖ NL = Aαα ð1=β - ð1 - αÞÞ1 - α ϖ NH = ∂ϖ NL ∂λ

< 0,

β

HN LN þ λð1 - σ ÞLM S

Aβ ααβ ð1 - αÞβ1 - ð1 - αÞβ LN þ λð1 - σ ÞLM S HN ð1 - ð1 - αÞβÞ1 - ð1 - αÞβ

∂ϖ NL ∂LM S

< 0,

∂ϖ NL ∂σ

> 0, and

∂ϖ NH ∂λ

> 0,

∂ϖ NH ∂LM S

> 0,

∂ϖ NH ∂σ

β ð 1 - αÞ

ð2:D4Þ

1 - ð1 - αÞβ

ð2:D5Þ

< 0: the three components

of globalization reduce the real unskilled wage and increase the real skilled wage.

The Real Income per Head The North real income per head iR  iR = Aαα ð1 - αÞ1 - α

β

ϖ NL LN þϖ NH H N LN þH N

is:

LN HN ω - βð1 - αÞ þ ω 1 - βð1 - αÞ LN þ H N N LN þ H N N

ð2:D6Þ

Appendices

71

Aαα ð1 - αÞ1 - α

∂iR = ∂ωN

β

LN þ H N × - βð1 - αÞLN ωN - 1 - βð1 - αÞ þ ð1 - βð1 - αÞÞH N ωN - βð1 - αÞ

∂iR > 0 is ωN > 1 -βðβ1ð-1 -αÞαÞ HLNN . This condition ∂ωN β ð 1 - αÞ LN 1 - βð1 - αÞ H N without globalization and ωN increases with

The condition for

always holds

since ωN = globalization. Hence, ∂iR/∂wN > 0 and finally: ∂iR ∂iR ∂iR > 0, ∂L M > 0 and ∂σ < 0: the three components of globalization augment the ∂λ S

real income per head.

Unskilled Tasks Are only Produced in the South Globalization reduces the skill premium ωN. A time comes when ωN reaches the value ωN = 1 -β β HLNN for which the unskilled tasks in manufacturing are no longer produced in North. For ωN , the price of the non-tradable service is sufficiently low to raise the demand and production of NT at the level for which all North unskilled workers are employed in this sector.29 From then on, the skill premium remains constant at ωN provided that the North relative skill endowment HN/LN remains unchanged. If the globalization dynamics continues (λ(1 - σ)LS rises) when the North unskilled labour is fully employed in sector NT, this dynamics increases the real unskilled wage,30 i.e. globalization becomes beneficial to unskilled workers.

Labour Market Imperfections Suppose that labour market imperfections and/or institutions impede the downward adjustment of the North unskilled wage. Following Davis (1998a, b), this can be modelled by assuming a skill premium lower than its equilibrium value defined by Eq. (2.D1). Then, if the markets for HN and LS are perfectly competitive, the adjustment operates by a reduction in LN, i.e. by unskilled unemployment in North (Eq. 2.D1), and this unemployment grows with globalization (increase in λ(1 - σ)LS). When all the unskilled labour LN is employed in sector NT, Y NNT = LN (NT production function), = pNNT (zero-profit condition in NT competitive market), and the demand function for NT is by Combining those relations yields assumption pNNT Y NNT = ð1 - βÞ wNL LN þ wNH H N . 29

wNL

ωN =

β 1 - β LN =H N ,

- ð1 - αÞ and ωN is attained when λ(1 - σ)LS reaches the value ð1=β 1 - αÞð1 - βÞ LN .

30 The rise in λ(1 - σ)LS increases the skilled wage relative to the price of good M, pM, and, since the North skill premium is constant, the North unskilled wage relative to pM increases as well, making 1-β . the North real unskilled wage to rise since the North consumer price is ðpM Þβ wNL

Chapter 3

Factor Mobility, Tax Base Mobility and Tax Competition

In addition to the development of North-South trade and North-South offshoring, the present wave of globalization is characterized by a large international mobility of firms, physical capital, financial capital and rich and talented individuals and professionals. Several changes have supported mobility. First, the institutional barriers which hindered mobility have been progressively erased (foreign investment controls, financial regulation, non-recognition of diplomas preventing the mobility of skilled workers, etc.), and advantages favouring the inflow of capital and rich taxpayers have been set. Second, technological changes and the development of new tools have substantially reduced the mobility costs (decreasing transport costs, new financial instruments and networks, etc.). Third, the multinationalization of firms and banks has reduced the costs and risks of investing abroad. Fourth, the development of English as lingua franca, the expansion of the internet and the internationalization of living and cultural standards, particularly for rich and skilled persons, have significantly reduced the personal and cultural costs of living abroad. In this new environment, firms, capital and educated persons can migrate in the country which is the most profitable for them with limited costs. As levies typically lessen income and wealth, the reduction in mobility costs encourages individuals and firms to transfer their tax bases and activities to countries with low taxation. Even if the cost of persons and workers’ mobility (migration cost) has indubitably shrunk, we have noted in Chap. 1 that no clear variation in the amplitude of migration can be diagnosed for advanced countries as a whole. This is not true for the most skilled and most talented workers. This chapter analyses the changes in tax and redistribution linked to the increasing mobility of capital, of firms and of high-skilled and talented workers and the related impact on inequality. By generating tax competition and a race to the bottom of the levies paid by the winners of trade openness, the increasing mobility of tax bases (i) prevents redistribution from the winners to the losers and (ii) magnifies their gain from globalization. Inequality is thus reinforced. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4_3

73

74

3

Factor Mobility, Tax Base Mobility and Tax Competition

The first section (3.1) exposes the general rationale of tax base mobility, tax competition and related race to the bottom. The second section (3.2) is devoted to the case of corporate tax and the third (3.3) to income tax competition. The literature on corporate and income tax competition is very large. Consequently, we only mention the major contributions and findings, and we refer to existing surveys for a broader review of the literature. A fourth section (3.4) briefly presents tax evasion, and we finally summarize the main findings on tax competition in Sect. 3.5.

3.1

Mobility of Tax Bases, Tax Competition and Race to the Bottom

The general condition for the outflow of tax bases is firstly exposed, and the impact of globalization is highlighted (Sect. 3.1.1). We subsequently explain the rationale of tax competition and the ‘race to the bottom’ dynamics by analysing the taxation choices of governments (Sect. 3.1.2).

3.1.1

Mobility of Tax Bases and Globalization

Consider two countries called Home and Foreign (* depicts Foreign values) and a tax base with value b which can represent capital, wealth, income, inheritance, etc. The base b belongs to a resident in the Home country, and it can be transferred to the Foreign country with a mobility cost C(b) such that C(b) > 0, b > 0. The mobility cost per unit of tax base c(b)
C(b)/b is assumed to decrease or to be constant with the value b. This assumption is realistic and consistent with both a mobility cost C(b) which increases with b but at a rate which is lower than or identical to that of b and a mobility cost decreasing with b. Globalization entails a decrease in the mobility cost C(b) and thus a decrease in the unit mobility cost c(b). Given the results of Chapter 2, we further assume that globalization comes with an increase in inequality in the distribution of tax bases. The tax rate on base b is τ in the Home country and τ in the Foreign country. Then, the net (after-tax and mobility cost) value of the Home base is (1 - τ)b in Home and (1 - τ)b - C(b) in the Foreign country. The base b moves abroad if its net value is higher in the Foreign than in the Home country, i.e. (1 - τ)b - C(b) > (1 - τ)b. The condition for the migration of the tax base is thus: τ - τ  > c ð bÞ Given the characteristics of c(b), there is a unique value b such that c b = τ - τ and all the tax bases smaller than b remain in the Home country, whereas all those

3.1

Mobility of Tax Bases, Tax Competition and Race to the Bottom

75

above b move to the Foreign country. This firstly reveals that the high-tax bases (b > b) leave the country, whereas the low-tax bases (b < b) stay in Home. Hence, the incentive to leave the country to escape from taxes primarily concerns rich taxpayers (high incomes, wealthy households, large and multinational firms, etc.). Consider now the globalization dynamics, i.e. the decrease in the mobility costs C(b) and c(b). The migration condition τ - τ > c(b) indicates that, for a given difference τ - τ > 0, globalization increases the number of tax bases which leave the Home country in two manners: 1. By lowering the unit mobility cost c(b) 2. By increasing inequality in the distribution of tax bases, which increases the amount of bases above b Consequently, by reducing the mobility cost and by increasing the amount of tax bases for which mobility is profitable, globalization is a powerful catalyst for tax base outflows. In addition, if the Home government wants to oppose those outflows, it must reduce the difference τ - τ by lessening its tax rate τ.

3.1.2

Tax Competition and Race to the Bottom

We now endogenize the choice of the tax rates, and we show how the mobility of tax bases generates tax competition and a race to the bottom. The reasons and mechanisms leading to tax competition and to a race to the bottom of tax rates can be summarized as follows: The mobility of tax bases encourages some countries to reduce their tax rates so as to attract foreign bases. Other countries respond by lowering their taxes to prevent the outflow of their domestic bases. Then, the former countries reduce even more their tax rates to attract bases entailing the same response of the latter. And so on. This sequence of decisions portrays a between-country tax competition generating a succession of tax cuts which entails a race to the bottom of tax rates in all countries. The above description reveals two possible strategies. The offensive strategy consists in lowering taxes to attract foreign bases. The defensive strategy consists in lowering taxes to prevent the outflow of domestic bases. The decision to implement tax cuts, either to attract foreign bases or to prevent domestic base outflows, typically depends on the governments’ objectives. In the economic literature, this is modelled by assuming that, in each country, the public social planner maximizes a welfare function depending on public expenditures financed by taxes (and often on other objectives which are hampered by taxes). To introduce globalization into this tale, let us assume that globalization comes with a lasting reduction of the mobility cost. A simple model of this type is exposed in Appendix. This approach leads to the following general features:

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1. There is a level of the mobility cost below which some countries are incited to lessen their tax rates so as to attract foreign bases. From then, a race to the bottom occurs which stops when the marginal benefit of lowering the rate equal its marginal cost. This equilibrium can be reached at a zero rate or even at a negative rate (subsidies granted to the bases) when the inflow of bases increases the recipient’s welfare. 2. Small countries adopt an offensive strategy, whereas large countries follow a defensive strategy. This feature stems from the costs and benefits resulting from the tax cuts, which differ according to the country size. The cost of reducing taxation is the decrease in levies on domestic bases, whereas its benefit comes from the extra levies perceived from the inflow of foreign bases. When the country is small, the cost of lowering the tax rate is lower than the related benefit because the amount of domestic bases is small compared to the potential inflow of foreign bases. The small country is then incited to lessen its taxation so as to attract foreign bases. In contrast, this offensive strategy is not beneficial to large countries because the inflow of bases is relatively small. Nevertheless, the large country typically follows the small country in its tax cuts because the related loss in taxes is lower than that resulting from the outflow of bases which completely cancel the related taxes. 3. If there is a level b below which the base is not transferred (as shown in Sect. 3.1.1), then the social planner can be incited to tax less the high bases (income, wealth, inheritance) than the small ones, which renders taxation regressive at the top.1 4. When the race to the bottom occurs, the countries lose welfare. This result depends of course on the welfare function. If the government objectives are contradictory with social welfare, then the cut in taxes may improve welfare. 5. Those outcomes are valid when the mobility of tax bases does not require the migration of their owners, i.e. in the case of source-based taxation in which tax is collected where the base is produced. They are also valid in the case of residentbased taxation (taxes are collected where the base owners live) when the base owners are mobile. In the case of resident-based taxation, the cost of migrating and living abroad must be included in the mobility cost. Tax competition essentially concerns capital, corporate tax and high income and wealth taxation for which the mobility costs are relatively low. Corporate tax on firms usually corresponds to source-based taxation and income tax to resident-based

1

A taxation schedule is regressive if the tax rate decreases with the value of the tax base (e.g. higher incomes pay proportionally less taxes than low incomes). In contrast, it is progressive when the tax rate increases with the value of the tax base. A flat taxation describes a situation with a tax rate which is constant whatever the value of the base. Taxation is regressive at the top if there is a value of the tax base (income, wealth, capital, etc.) above which taxation is regressive and below which it is progressive or flat.

3.2

Corporate Tax Competition

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taxation.2 We now briefly present the major findings of the economic literature on corporate tax and income tax, the two major types of taxation analysed in the literature.

3.2

Corporate Tax Competition

Following the seminal articles of Zodrow and Mierzkowski (1986) and Wilson (1986), the analysis of corporate tax competition has known a large development over the last decades, both theoretically and empirically. The first works were centred on corporate tax competition between regions because the tax and welfare distortions linked to capital mobility between American states were a major concern in the USA, the world being characterized by high international mobility costs. The between-jurisdiction tax competition approaches can be extended to betweencountry analyses.

3.2.1

Theoretical Approaches

The basic idea of corporate tax competition (CTC) is that capital mobility incites multinational firms to locate their capital, production and profits in the countries where the corporate tax is low. Consequently, governments are themselves incited to decrease the corporate tax rate so as to attract capital from abroad or to prevent capital outflows. As explained above, this generates a ‘race to the bottom’ between countries in terms of corporate taxation. CTC can take two major forms: (1) firms can move to the countries where the corporate tax is low, and (2) firms can make appear their profits in the low-tax countries through intra-firm price setting between affiliates localized in different countries (Bartelsman & Beetsma, 2003). Other practices with the same type of impact are possible: changes in the composition of the compensation for executives and other employees (increase of the wage share of executive compensations), financing of affiliates by loans granted by other affiliates, strategic location of intellectual assets as intellectual property, etc. A first strand of theoretical literature has shown that CTC leads to suboptimal situations in terms of social welfare. From a simple framework with an infinite number of identical regions, Zodrow and Mierzkowski (1986) showed that capital mobility-related tax competition leads to suboptimal situations characterized by low capital taxation and under-provision of public goods. Wildasin (1988) extended this model to the case of a finite number of countries that are sufficiently large to

2 Inheritance taxation can be treated as income taxation because it is linked to the mobility of persons.

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influence the after-tax return to capital, with the same results in terms of suboptimality. The same outcomes are also determined, but with differences in the tax rates across countries at equilibrium, when assuming asymmetries between economies in terms of size (Kanbur & Keen, 1993) and capital per capita (Wilson, 1999). One limit of these models is that they assume source-based corporate taxes (the tax is perceived where the firms produce). Assuming residence-based taxation (tax perceived where the capital owner lives) typically abolishes tax competition and re-establishes optimality3 (Bucovetsky & Wilson, 1991; Razin & Sadka, 1991). However, residence-based taxation is difficult to enforce because of the lack of information-sharing between countries (Frenkel et al., 1991), even if informationsharing has improved in the last decade. Rich capital owners can also decide to move from high-tax to low-tax countries. In addition, the tax cuts can be moderated when public expenditures improve the position and benefits of firms (Benassy-Quéré et al., 2007). Finally, when, unlike capital, labour is not mobile, then a small country typically taxes labour only, whereas a large one still maintains a reduced taxation on capital, with however a loss of welfare in both countries (Bucovetsky & Wilson, 1991). Of course, the results in terms of optimality are conditioned by the hypothesis of a benevolent public planner. In the case of a Leviathan-type public agent, tax competition can in contrast improve efficiency by tempering the tendency to over-taxation (Dhillon et al., 2007).

3.2.2

Empirical Evidence

Corporate tax competition can be tested and estimated in several ways. Firstly, one can estimate the social planner’s reaction function by verifying that there is a positive relationship between the tax rate in one country and the tax rates abroad. Secondly, one can verify the impact of corporate taxation upon FDI inflows and outflows. Thirdly, one can verify that higher capital mobility or growing globalization reduces corporate taxation. The results of the empirical literature depend on the indicator selected to measure corporate taxation. A first type of empirical literature puts forward the evidence of strategic interactions among governments in the setting of corporate taxation (Zodrow, 2010, for a review). From a sample of 21 OECD countries, Devereux et al. (2008) analysed the MNEs’ investment decisions. They found strong evidence of international tax competition over statutory corporate tax rates in the period 1982–1999: a 1% reduction in the weighted average statutory tax rate in other countries results in a 0.7% reduction in the home country tax rate. Using data for 32 European countries from 1983 to 2006, Overesch and Rincke (2011) showed that countries clearly compete over statutory tax rates. They compared the observed tax rates with the

3

Note that this is true only if capital owners do not migrate.

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Corporate Tax Competition

79

rates obtained by simulation assuming no tax competition between countries. They find that in the absence of CTC, the mean statutory corporate tax rate in 2006 would have been of about 12.5 percentage points above its actual level in Western Europe. Hence, CTC could explain a large part of the decline of corporate tax in the 1990s and 2000s. As regards the effect on FDI, a majority of empirical works came to the conclusion that the countries’ corporate tax has had a negative impact on FDI inflows (see the reviews by De Mooij & Ederveen, 2006; Devereux & Maffini, 2007). Some studies also reveal that the tax sensitivity of FDI has increased over time (Altshuler et al., 2001; De Mooij and Ederveen, 2008; Feld and Heckemeyer, 2011). Barrios et al. (2012) show that corporate taxation in both the parent and the host country has an impact on the location of new foreign subsidiaries. The evidence on the impact of capital mobility and globalization upon corporate taxation is more mixed. If corporate taxation is measured by statutory tax rates, then CTC is confirmed, and the last 30 years have indisputably witnessed a convergence in corporate tax rates across countries (Bénassy-Quéré et al., 2007; Cassette & Paty, 2008; Devereux et al., 2008; Devereux & Fuest, 2012). In contrast, international capital mobility increases corporate taxation when the latter is measured either by the corporate taxes on GDP ratio or by the effective corporate tax rate, i.e. the ratio of corporate levies on corporations’ profits (Slemrod, 2004; Hines, 2005; Mendoza & Tesar, 2005; Dreher, 2006a; Devereux et al., 2008; Devereux & Fuest, 2012). So, the decrease in the statutory tax rate must have been offset by an increase in the tax bases (Hines, 2005) or by higher returns to capital. Facing the mixed evidence on the impact of capital mobility, several points have been analysed which could explain a positive impact of globalization upon corporate taxation. At least, five major channels have been identified: 1. The ‘agglomeration effect’: The reduction in transport costs (globalization) increases the benefits of agglomeration (concentration of similar activities in the same country or area). Corporate tax can then increase as long as the benefits from agglomeration exceed the costs of taxation (Baldwin & Krugman, 2000; Kind et al., 2000; Ludema & Wooton, 2000). 2. The ‘compensation effect’: Globalization increases inequality and social risks (e.g. linked to the restructuring of the production), implying growing social expenditures financed by taxes. 3. Inequality can make people to vote more ‘left’, i.e. pro-tax, because it impoverishes the median voter. This is particularly the case when the median voter wants to offset the influence of tax competition on the policy-maker decision (Persson & Tabellini, 1992). 4. Pro-firm public expenditures: The negative effect of corporate taxation can be offset by the positive effect on corporate profit of goods and services offered to firms. The estimates implemented by Bénassy-Quéré et al. (2007) confirmed this analysis. 5. If the activities of MNEs’ affiliates are complementary and based on a comparative advantage-driven division of labour, then an increase in the corporate tax

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rate in one country will lessen the MNE’s capital stock in both the country where it is implemented and the countries where the firm has affiliates. Becker and Riedel (2012) found evidence of this mechanism for the European MNEs. Finally, the sensitivity of empirical results to the corporate tax indicator is not really surprising. Each indicator displays shortcomings, and capital mobility could come with an increase in corporate levies measured either by the taxation on GDP ratio or by the effective tax rate: 1. An increase in the return to capital in total income combined with a decrease in the statutory corporate tax rate can increase corporate taxation as a % of GDP when the former is higher than the latter. 2. If one can discriminate between sectors or firms through targeted tax exemptions that modify the tax bases, then the government can concentrate the corporate tax burden upon the non-globalized firms. Several works tend to show that non-globalized middle-sized enterprises suffer an effective tax rate that is significantly higher than multinational corporations. All in all, Heimberger’s meta-analysis (2021) tends to confirm the CTC hypothesis.

3.3

Income Tax Competition

The analysis of income tax competition (ITC) can be seen as an extension of the literature on optimal tax rates introduced by Mirrlees (1971). Following Mirrlees, the optimal income tax rate is determined by a game between the government and the tax payers. When increasing the marginal income tax rate, the social planner discourages labour supply and effort, which in turn lessens the amount of income and the perceived taxes. Based on the impact of taxes on labour supply within a closed economy, this literature does not deal with the globalization-inequality nexus and is thereby not examined here. Let us just mention that Mankiw et al. (2009) distinguish several major results whose recommendations have been only partially followed by policy-makers in the last decades: (1) Optimal marginal tax rate schedules depend on ability distribution; (2) The optimal marginal tax schedule can decline for high incomes; (3) A flat tax with a universal lump-sum transfer could be close to optimal; (4) The optimal redistribution rises with wage inequality; (5) Taxes should depend on both personal characteristics and income; (6) Only final goods ought to be taxed and typically uniformly; (7) Capital income ought to be untaxed, at least in expectation; (8) In stochastic, dynamic economies, an optimal tax policy requires increased sophistication. Centred on the influence of the marginal income tax rate upon the individuals’ labour supply and on its impact on welfare, this literature does not consider migration as an answer to avoid high levies. Yet the calculations of the influence of taxation on labour supply indicates a rather weak impact, particularly for high-

3.3

Income Tax Competition

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skilled male who are at the top of the earnings ladder and are subject to the top marginal income tax rates (Saez et al., 2012; Blundell, 2014). In contrast, the evidence of the influence of taxation on high incomes’ migration is now well established (Kleven et al., 2020 for a survey).

3.3.1

Theoretical Approaches

The theoretical literature on the impact of the migrations of taxpayers and transfers recipients on income taxation and redistribution has known a large development over the last decades. Those analyses determine various and sometimes opposite outcomes depending on the model and its assumptions. The impact of labour mobility on optimal income taxation was introduced by Mirrlees (1982). The subsequent literature has focused on the behaviour of jurisdictions competing in income taxation and social transfers facing the potential migration of both net taxpayers and net transfer recipients. The key mechanisms of migration-based income tax and transfers competition can be summarized as follows. Income taxes are paid by individuals and collected by the governments to finance social transfers. Individuals can migrate from one country to another so as (i) to escape from taxation and (ii) to benefit from social transfers. The net taxpayers (individuals whose taxes are higher than the transfers they receive) migrate if their net taxation (taxes-transfers) in the foreign country plus the migration cost is lower than their net taxation in their home country. The net transfer recipients (individuals whose taxes are lower than the transfers they receive) migrate if their net transfers (transfers-taxes) in the foreign country minus the migration cost are higher than the net transfers they receive in their home country. The countries’ social planners maximize a welfare function which depends on taxes and transfers through several channels. Social transfers improve individuals’ welfare in the country and attract foreign immigrants with low incomes. The income tax permits to fund redistribution, but it encourages high incomes to leave the country. As usual in tax competition approaches, lowering the marginal income tax rates permits to attract high incomes and to prevent their emigration, but it can also reduce social transfers, which tends to counter the inflow of poor foreigners and lessen the low-income earners’ welfare. Everything then depends on the shape of the social planner’s welfare function. Two types of characteristics are key in the determination of the equilibrium: (1) the weight of redistribution (preference for equality) in the welfare function and (2) the individuals whose welfare is considered by the social planner. In this respect, the social planner can be national-oriented (he considers all nationals, residents and non-residents), resident-oriented (he considers all residents, national and immigrants) or citizen-oriented (he considers national residents only). In the equilibrium with perfect mobility, the benefits must be equal across jurisdictions for net taxpayers and for net transfer recipients (Wildasin, 1991), which can be achieved either by coordination or by a central government. With no between-jurisdiction coordination and no central adjustment, Hindricks (1999)

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determined the Nash equilibria when the poor and the rich are imperfectly mobile and jurisdictions compete in tax, in transfers or in both. This analysis determines three major results: (1) The cut in redistribution is larger when competing in transfers than when competing in taxes; (2) Logically, the mobility of the rich is detrimental to redistribution; (3) The effect of the mobility of the poor depends on whether jurisdictions compete in taxation or in redistribution. When countries diverge in productivity, migration can however foster tax progressivity in the highly productive country (Bucovetsky, 2003). In a series of papers, Simula and Trannoy (2005, 2010, 2012) have analysed taxation and welfare when countries are competing in income taxes because of labour mobility. In those approaches, skill and productivity differ across individuals, and the impacts of taxes on both labour supply and taxpayers’ migration are taken into account. In the determination of the optimal tax structures, the authors make a double distinction (i) between national-oriented, citizen-oriented and resident-oriented welfare functions and (ii) between the cases of perfectly known and imperfectly known individual productivities. All configurations lead to tax competition and cuts in redistribution. In several configurations, the marginal tax rates on the highest skills are reduced, and regressivity at the top can be optimal.4 Those analyses can also generate a middle-skilled curse: individuals situated in the middle of the skill ladder pay more taxes to offset the losses in the funding of redistribution due to the decrease in high-skilled workers’ income tax (see Sect. 4.2.1 in Chap. 4 hereafter). Bierbrauer et al. (2013) analyse the choices of income tax systems in a model with tax competition between two countries, a welfare function depicting the average utility of residents, non-observable skills and perfect mobility across countries. They show that there is no equilibria in which individuals with the highest skill make positive tax payments and no equilibria in which the lowest-skilled residents receive a subsidy, in either country. In equilibrium, it is even possible for the highest skilled to receive a net transfer funded by taxes on lower-skilled individuals. Lehmann et al. (2014) find the optimal marginal income tax rate determined by the Nash equilibrium between two Rawlsian governments (maximin) maximizing a welfare function when individuals differ in both skills and migration costs. The solution crucially depends on the semi-elasticity of migration (percentage change in the mass of migrating taxpayers of a given skill induced by a unit change in their consumption). Several simulations are made for the USA, revealing a welfare loss between 0.4% and 5.3% for the worst-off and a gain between 18.9% and 29.3% for the top 1%. Landier and Plantin (2017) develop a model in which an inequality–adverse government faces individuals which can hide their income (consumption) with a tax-avoidance technology characterized by subadditive costs. They show that because of the shape of the tax-avoidance function, the government optimal taxation scheme cannot be progressive at the top.

4

Remember that regressivity at the top refers to situations in which the marginal tax rate decreases above a certain level of income.

3.4

Tax Evasion

83

Hellier (2021) shows that if globalization is characterized by a decreasing cost of mobility, there is a cost level below which the income tax structure must be regressive at the top so as to achieve the government’s goals. The results of Tobias (2016) are slightly different. Assuming a finite number of countries with governments maximizing the welfare of low-skilled workers by taxing high-skilled workers’ labour income, the author shows that a race to the bottom does not always emerge. In this model, skilled workers have location preferences, and the preservation of the welfare state then depends on the shape of the probability distribution of those preferences.

3.3.2

Empirical Evidence

The decrease and the convergence of top marginal income tax rates are well documented, but their relation with the threat of migration is not easy to determine. Nevertheless, a rather recent empirical literature shows that income tax-driven migration and ITC do exist. Because of its key position as a tax haven, Switzerland has been particularly studied. Feld and Reulier (2009) diagnose a race to the bottom dynamics among the Swiss cantons, with however no full convergence because of cultural divergence. Schaltegger et al. (2011) conclude that income taxes do have an influence on the residence of taxpayers in Zurich area. Based on Swiss bank deposits, Johannesen (2014) analyses the impact of the reform introducing a withholding tax which limits tax evasion on interest income for EU residents but not for non-EU residents. He observes a large decline in EU residents’ deposits relative to non-EU deposits after the reform, suggesting that non-Swiss deposits are to a large extent motivated by tax evasion. Kleven et al. (2014) studied the Danish preferential foreigner tax scheme introduced in 1991. They show that this reform has had a significant effect on the inflow of highly paid foreigners. Finally, several works have analysed the taxation-related migration of specific categories of rich and talented workers (Kleven et al., 2013, for top football players in 14 European countries; Akcigit et al., 2016, for top 1% inventors in 8 OECD countries). These works typically show a significant impact of taxation on migration. A review of the empirical literature on the income tax-migration relationship at the international and national (between-jurisdiction) levels can be found in Kleven et al. (2020, see Table 1, p. 121).

3.4

Tax Evasion

Tax competition is based on tax optimization, which is a legal behaviour of firms and individuals. Tax evasion is different because it concerns tax bases underreporting and is thereby illegal. It is thus a risky behaviour which entails costly penalties if it is

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discovered by tax authorities. This risk and the related costs must be accounted for by those who engage in tax evasion.

3.4.1

Tax Evasion: Basic Mechanisms

The seminal theoretical model of tax evasion is that of Allinghjam and Sandmo (1972). In their approach, tax evasion concerns income, but the reasoning can be extended to wealth or any other reported tax base. The model considers an individual who decides on her/his non-reported income share which escapes from taxation (evasion). There is a probability to be investigated by tax authorities, and, if so, the taxpayer has a penalty on her/his non-reported income which is higher than the tax she/he would have paid without evasion. The taxpayer’s optimal evasion share is then determined by maximizing the expected net (after tax and penalty) income. In the static model, this optimal share has the following characteristics: 1. The taxpayer declares less than her/his actual income if and only if the expected tax payment on undeclared income (probability to be discovered × penalty rate) is lower than the regular tax payment (tax rate). 2. The impact of the income level on the non-reported income share is ambiguous and depends on the function which binds the relative risk aversion to income. This feature shows that rich taxpayers are not always incited to underreport a higher share of their income than those with low incomes. 3. The influence of the tax rate on the non-reported income share is also ambiguous in the authors’ most preferred (realistic) configuration where the absolute risk aversion decreases with the income. 4. Both the probability of being investigated and the severity of the penalty reduce tax evasion, which is confirmed by laboratory and field experiments (see, for example, Slemrod et al., 2001; Kleven et al., 2011; Rincke & Traxler, 2011). Those are thus two substitutable tools in the hands of tax authorities to discourage tax evasion. 5. High incomes could evade less if they are more likely to be audited than low and middle incomes. A higher probability to be audited for high incomes can be justified by the fact that for a similar auditing cost and evasion likelihood, the tax gain from a rich taxpayer is larger. Allingham and Sandmo subsequently extend their model to a dynamic case in which the individual lives several periods of time and, once an individual’s evasion is discovered, she/he must pay the penalties for the evasions of all the preceding periods. The major findings of the dynamic model are as follows: (1) The condition for an initial under-declaration is the same as in the static model. (2) The non-declared income share decreases over time, which is logic since the penalties increase over time. This basic model can be used to analyse the impact of globalization on tax evasion.

3.4

Tax Evasion

85

First, if the growing international mobility of capital (globalization) comes with new financial technologies lessening the probability to be discovered when cheating, then globalization reinforces tax evasion. This is particularly the case when, because of financial sophisticated instruments, the tax authorities’ auditing costs significantly increase. Second, if those new pro-evasion financial tools are costly, then the related cost must be inserted in the calculation of the optimal tax evasion. In addition, if this cost is sufficiently high and includes a non-negligible fixed part, then the increasing tax evasion concerns the sole higher incomes (Guyton et al., 2021). This last explanation has nevertheless been challenged because the fixed costs of creating shell companies and offshore bank accounts are rather modest (Findley et al., 2012, for shell companies). Alstadsaeter et al. (2019) propose another explanation for the concentration of offshore evasion among the richest. For a provider of evasion services, increasing the number of customers means a higher probability to be caught when helping tax evaders. Since, on top of the fixed cost, the evasion services provided by banks and financial companies are paid as a percentage of hidden wealth and incomes, those providers are incited to limit the number of customers to the richest. This is what they do by requiring a minimum amount of assets to their customers. In summary, globalization (high mobility of financial capital) combined with new financial tools fosters tax evasion, and the evasion service providers limit the access to those services to the top of the income and wealth ladder. This result can obviously be extended to any other tax base whose mobility depends on financial flows.

3.4.2

Tax Evasion: Weight and Impact

To the best of our knowledge, there is no empirical study of the direct links between globalization and tax evasion. The literature is rather centred on the questions of the magnitude of tax evasion and on the difference in evasion depending on the income and wealth of taxpayers. A distinction is typically made between the extensive margin (Are rich taxpayers more likely to be evaders?) and the intensive margin (Do rich taxpayers underreport more?). The existing literature tends to respond yes to the first question and no to the second. Exploiting two sets of leaks from financial institutions (‘HSBC Swiss leaks’ and ‘Panama papers’) for Scandinavian countries (Denmark, Norway and Sweden), Alstadsaeter et al. (2019) find that (i) the probability of offshore tax evasion significantly increases with wealth, and this is also the case within the group of wealthiest taxpayers, and (ii) within the group of tax evaders, the percentage of evasion is about 40% and does not vary with wealth. Guyton et al. (2021) show that random audits which are the usual way to study tax evasion underestimate evasion at the top of income distribution because they do not detect the most sophisticated evasion means. They correct this bias and find that the non-reported income sharply increases with the value of income, from 7% for the bottom 50% up to 20% for the top 1%.

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Factor Mobility, Tax Base Mobility and Tax Competition

Major Lessons on Tax Base Mobility, Tax Competition and Tax Evasion

The analyses presented in this chapter and the literature dealing with the impact of growing factor mobility on tax competition lead to several key results: 1. Considering a tax base (income, wealth, capital, inheritance, etc.), if tax rates differ across countries and if the tax base mobility is costly, then there is a threshold value (mobility threshold) above which the bases leave the country and below which they stay in the home country. Hence, the rich taxpayers leave the country and the poor or middle taxpayers do not. 2. Globalization fosters the mobility and the outflows of tax bases by reducing the mobility costs and by increasing inequality, i.e. the amount of bases above the mobility threshold. 3. The mobility of tax bases generates tax competition and a race to the bottom: Some countries lessen their taxes to attract foreign bases (offensive strategy), and other countries lessen their tax to prevent the outflow of their bases (defensive strategy), leading the former to lessen even more their taxes with the same response of the latter, and so on. 4. Small countries typically have an offensive strategy, whereas large ones have a defensive strategy. 5. Governments can set taxation schemes which are regressive at the top with possibly negative rates on the highest bases (income, wealth), even if they are equality-oriented and pro-redistribution. 6. Financial globalization combined with sophisticated financial technologies foster tax evasion by lessening the probability to be discovered when cheating. 7. The providers of tax evasion services (banks, financial establishments) tend to restrict the access to those services in favour of the richest, i.e. the top of the income and wealth ladder. 8. Empirical evidence tends to confirm (i) the existence of tax competition and race to the bottom, (ii) the concentration of the tax cuts on the top of the income and wealth spectrum and (iii) the concentration of tax evasion among the richest taxpayers. Putting together the majors lessons of Chap. 2 (North-South trade) and Chap. 3 (mobility of tax bases), we can establish the following diagnosis: The development of North-South trade increases inequality between the highskilled and the capital owners on the one hand and the low- and middle-skilled on the other hand, but it could be beneficial to everyone provided that transfers are made from the winners to the losers. Unfortunately, the increasing mobility of factors and tax bases prevents this redistribution programme since both legal tax avoidance and illegal tax evasion primarily benefit to the richest, i.e. the winners of NST. This increasing mobility even reinforces the NST-generated inequality because it lessens the tax burden of the winners through tax competition and the race to the bottom which essentially concerns high incomes and the wealthiest households.

Appendix: Mobility of Tax Bases and Race to the Bottom

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In a nutshell, the two major components of the present wave of globalization, NST and factor and tax base mobility, reinforce each other to increase inequality between the top of the income and wealth spectrum on the one hand and the lower and middle classes on the other hand. Consequently, the characteristics of the ongoing globalization dynamics crucially modify the patterns of public policies and social and labour market institutions. Those modifications have already been partially exposed in the present chapter. The next chapters are dedicated to a broader analysis of those changes.

Appendix: Mobility of Tax Bases and Race to the Bottom Consider a world with: 1. Two countries, Home and Foreign, with the respective populations N and N* (Foreign values are starred). 2. Tax bases are distributed in the population in the intervals b, b in Home and  b , b in Foreign, with the distribution functions f(b) and f (b). We denote B = N b b × f ðbÞdb and B = N  b b × f  ðb Þdb the total amount of tax bases in Home and Foreign. 3. The governments’ objectives are to provide given amounts of public services, G in Home and G* in Foreign, with the lowest possible uniform tax rates. G and G* increase with the number residents in the related country. 4. Let τ and τ be the uniform tax rates which ensure the financing of the governments’ objectives G and G* when tax bases are not mobile. We assume to simplify that those rates are identical: τ = τ .5 They consequently prevail before the setting of mobility. 5. There is a mobility cost C(b) which depends on the value of the moving tax base with the unit mobility cost c(b) = C(b)/b being a decreasing function of b. With a couple of tax rates (τ, τ), τ < τ, all the Foreign bases b* such that τ > τ + c(b), i.e. b > b = c - 1 ðτ - τÞ, move to Home. Home benefits from the inflow of all the Foreign bases higher than b. It is clear that the lower (higher) τ, the lower (higher) b, and the higher (lower) the amount of Foreign tax bases moving to Home: For a given τ, b is an increasing function of τ. b

b

We focus on the Home government’s behaviour (the Foreign government’s behaviour can be analysed symmetrically), and we suppose that the world moves from a regime of institutional immobility to a regime of institutional mobility of tax bases. We define the initial bðτÞ as bðτÞ = c - 1 ðτ - τÞ = c - 1 ðτ - τÞ. An inflow of

5

This permits to have no base transfers when bases become mobile with the initial tax rates.

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Foreign bases requires that bðτÞ < b , i.e. a Home rate τ lower than τ - c b . If Home lessens its tax rate from τ = τ to τ < τ - c b ,6 its levies move from τ × B to τ(B + IB), IB being the inflow of bases from the Foreign country. This inflow is the sum of the Foreign bases moving to the Home country, IBðτÞ = N 

b     b^ðτÞ b f ðb Þdb .

A decrease in the tax rate τ entails a decrease in b and hence an increase in the inflow of Foreign tax bases IB. In other words, IB is a decreasing function of τ. We can distinguish between source-based taxation (tax is collected where the base is produced) and resident-based taxation (tax is collected where the base owner lives). In the first, tax bases are mobile, but their owners can remain in Foreign, the resident population of Home being then unchanged. In the second case, the base owner must leave the country to pay her/his tax abroad, which increases the number of Home residents. We assume that each government makes its decision by taking the other country’s tax rate as given (Nash game).

Source-Based Taxation The resident population being constant, the Home government’s goal in terms of provision of public services is unchanged. The cut in the tax rate from τ to τ < τ makes the Home levies move from T = τ × B to T(τ) = τ(B + IB(τ)). A decrease in tax rate has two opposite impacts on Home levies. First, the decrease in τ reduces the collected taxes by the amount ðτ - τÞB. Second, the inflow of tax bases IB entails an increase τ × IB(τ) of the Home levies. The condition for the government to be incited to reduce its tax rate so as to increase the collected taxes is thus: IBðτÞ >

τ-τ B: τ

As IBðτÞ = N  ^b b f  ðb Þdb and B = N mining for this condition to hold: b

b b b × f ðbÞdb,

two elements are deter-

1. The size of Foreign tax bases must be large compared to that of Home. This typically means that relatively small (N < N*) and relatively poor (B < B*) countries are more likely to fulfil this condition. 2. An unequal distribution of Foreign tax bases also fosters the fulfilment of this condition by increasing the amount of bases above b. Suppose that there are some τ < τ such that IBðτÞ > τ -τ τ B. Then, the Home government chooses the smallest τ < τ, τ0, which permits to achieve its objective

6

Remember that τ = τ .

Appendix: Mobility of Tax Bases and Race to the Bottom

89

G, i.e. such that T ðτ0 Þ = T.7 This induces an outflow of Foreign tax bases IB(τ0). The Foreign government is then incited to reduce its tax rate at a level just below τ0 + c(τ0) so as to impede the outflow of Foreign tax bases, provided that ðτ0 þ cðτ0 ÞÞB > τ ðB - IBðτ0 ÞÞ. If ðτ0 þ cðτ0 ÞÞB < τ ðB - IBðτ0 ÞÞ, the Foreign government is not incited to respond to the decrease in the Home tax rate, and the couple ðτ0 , τ Þ is a Nash equilibrium. This equilibrium corresponds to an increases in welfare for Home (G can be achieved with a lower tax rate) and a decrease in welfare in Foreign (G* is no longer achievable). If ðτ0 þ cðτ0 ÞÞB > τ ðB - IBðτ0 ÞÞ, the Foreign government sets the tax rate (τ0 - c(τ0)) to prevent the outflow of bases, making the Home government to reduce its rate just below τ0 to ensure the inflow, and so on. This generates a race to the bottom.8 Note that (1) the small Home country has a tax rate smaller than that of the large Foreign country during the race to the bottom dynamics and at the equilibrium, (2) the race to the bottom reduces both countries’ welfare (they no longer reach their goal) except when it stops rapidly (in this case, the sole Foreign country loses welfare), and (3) as globalization entails a continuous decrease in the migration cost C(τ), the race to the bottom is permanently reinforced, and the between-country tax rate gap shrinks.

Resident-Based Taxation When the location of tax bases cannot be separated from their owners, the migration of bases comes with the owners’ migration, and an inflow of bases entails a rise in the population of residents. Since the provision of public services increases with the number of residents, the inflow of tax bases tends to increase this provision. In this case, the above mechanism operates, but the inflow of bases must now compensate both the decrease in the tax rate and the increase in the provision of public services. Then, the concentration of the Foreign bases in the hands of a limited number of taxpayers, i.e. an unequal distribution of bases, becomes a key factor to make the decrease in the tax rate beneficial because the amount of bases then increases more than the related number of residents. Then, both the size (number of bases) of the country and the uneven distribution of bases are determining. Finally, note that the above arguments suppose either that the race to the bottom takes place without tax bases migration (changes in tax rates occur before mobility) or that the repatriation of bases is costless. When the repatriation of bases is costly, this cost as well as the probability of future changes in the countries’ tax policies must be inserted in the taxpayer’s calculations.

7 There can be several τ such that T ðτÞ = T, depending on the shape of the distribution function f(b). If b × f(b) increases with b, then this value is unique. 8 The race to the bottom ends once the Home rate reaches the value τ such that τ = cðτÞ.

Chapter 4

Anti-inequality Policies and Globalization

In Chap. 1, we have shown that globalization has been accompanied in advanced countries by critical changes in the tax structure, by a general progression of public social expenditures, by a stability of redistribution rates and by an upsurge of public debts. In Chap. 2, we have examined the impact of the setting of a minimum wage, and more broadly of policies increasing the reservation wage, in the North-South HOS approach as well as in the case of offshoring in tasks. In Chap. 3, we have analysed the mechanisms through which the mobility of tax bases leads to tax competition and limits thereby the financing of public policies and redistribution. This chapter tackles the issue of governments’ policies facing growing inequalities within a globalized economy. Governments can firstly not intervene and let inequality rise. They can in contrast try to compensate the losers’ damages. Considering those opposite strategies, the economic literature makes a distinction between the so-called efficiency effect (globalization reduces public social expenditures because of between-country tax and social competition) and compensation effect (globalization fosters public expenditures by increasing the demand for social insurance against the new risks).1 If a partial compensation of the losers’ damages has been observed in most countries, the implemented policies tend to generate (i) an inequality-unemployment trade-off, (ii) a progressivity-redistribution trade-off and (iii) a middle-class curse, a social-democracy curse and a rise of populism. In addition, the constraint on the funding of redistribution can lead governments to accept public deficits and to increase public debt. Finally, since globalization-driven inequality primarily hurts unskilled and middle-skilled workers, a straightforward solution to this problem consists in a general skill upgrading by expanding tertiary education. But globalization itself, and globalization-driven inequality in particular, can hamper the access to higher education.

1

Meinhard and Potrafke (2012) for a presentation of the efficiency effect vs. compensation effect debate.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4_4

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Labour Market Institutions and the Inequality-Unemployment Trade-Off

In Chap. 2, we have investigated how certain characteristics of labour market institutions could modify the effects of trade on inequality and employment. In particular, the setting of a minimum wage and/or labour market institutions and rules that increase the reservation wage prevent wage adjustment and lead to unemployment. We now reverse the question by analysing how globalization can incite governments to modify labour market rules and change the balance of power on labour markets.

4.1.1

The Inequality-Unemployment Trade-Off

There is an inequality-unemployment trade-off (IUT) constraint on economic and social policy when the policy-maker must accept rising unemployment if she/he wants to reduce inequality and accept rising inequality if she/he wants to reduce unemployment.2 Initially presented by Krugman (1994) and Blank (1997), the basic mechanisms of the IUT have already been explored in Chap. 2 (Sects. 2.1.4, 2.1.5 and 2.2.2) when we introduced labour market imperfections to generate unemployment in the North-South HOS model and in the offshoring in task model. Most of those imperfections are caused by anti-inequality policies. This is obvious for the setting of a minimum wage, but it is also true for all social policies that raise the reservation wage: unemployment subsidies, free provision of certain services, antipoverty subsidies and all forms of redistribution which are not conditioned by a working activity. Dismissal indemnities and protections have the same impact because they increase the labour cost. The way by which the IUT operates is simple. By raising low wages above their full-employment value, social policies and rules reduce inequality and create unemployment of the unskilled. Then, relaxing the rules and liberalizing the labour market permit to reduce unemployment, but this is obtained by an increase in inequality. Finally, globalization generates an IUT dynamics because it puts a lasting downward pressure on the unskilled wages, encouraging thereby the setting of policies preventing their reduction. It must be stressed that the reduction in inequality concerns employed workers. For this reduction to operate at the total population level, the unemployment subsidies must be sufficient to prevent an excessive impoverishing of the unemployed. But this reinforces the IUT by raising the reservation wage.

2

See Dumont (2013) and Bikakova (2014) for reviews of the literature on the inequality-unemployment trade-off.

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Labour Market Institutions and the Inequality-Unemployment Trade-Off

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Several approaches generating an IUT have already been examined in Chap. 2 (Krugman, 1994; Davis, 1998a). From a North-South HOS-type approach with a large number of Northern countries differing in their skill endowments and a continuum of goods differing in their skill intensities, Hellier and Chusseau (2010) have shown that the growing size of the South (globalization) magnifies the inequality-unemployment trade-off and that the IUT is more intense in Northern countries which were initially (before the emerging of the South) inequalityoriented. This is because (i) inequality increases with the relative endowment in unskilled labour and (ii) the growing size of the South modifies all the more the sectoral specialization of North countries as their relative unskilled labour endowment is high. A broader presentation of this model is made in Sect. 2.1.5 and Fig. 2.4. In the case of Germany, Beissinger et al. (2016) diagnose the prevalence of an IUT from the mid-1990s linked to the combination of the large offshoring of low-skilled tasks and the setting of labour market reforms. Those reforms, in particular the Hartz laws, have liberalized the German labour market and reduced the German reservation wage. Germany has succeeded in reducing offshoring-based unemployment, but this has been obtained by increasing the incidence of low wages and in-work poverty. The empirical evidence on the IUT is rather mixed, and Dumont (2013) considers the results as inconclusive. There is in fact a difficulty in estimating the existence and intensity of the IUT because the rise in unemployment can take two forms: declared unemployment, which is registered in labour statistics, and non-participation in the labour market, which is not. Then, a number of potential workers who keep outside the labour market because their market wage is lower than their reservation wage are not accounted in the unemployment statistics. Moreover, the reforms implemented in several advanced countries in the 1990s and 2000s which imposed an active search of work to obtain unemployment subsidies tend to dissuade the registration on the unemployment list. Finally, the analysis and simulations made by Hellier and Chusseau (2010) suggest that the IUT intensity could substantially differ across countries. The determinants of those differences (relative skill endowment, but also sectoral sensitivity to the competition from emerging countries, weight of trade in the countries’ GDP, etc.) must then be considered in IUT estimates. Based on data from France, the UK and the USA, Bikakova (2014) found clear evidence in favour of the IUT hypothesis. In addition, she finds that minimum wages increase wage rigidity at the bottom of the wage distribution, whereas collective bargaining increases rigidity at all wage levels. In summary, the IUT hypothesis is confirmed by the comparison of France with the UK and the USA as well as by the experience of Germany which moved from high unemployment and low inequality before the labour market reforms to low unemployment and rather high inequality and in-work poverty after the reforms. However, the existing literature does not allow a general acceptance of this hypothesis.

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Globalization and Unionization

Unions’ behaviour and bargaining are well-known determinants of wage setting and wage rigidity. Analysing the impact of bargained wages on inequality and employment in a globalized economy could just be made in the same manner as for minimum wages or social policies, i.e. by assuming a wage which differs from its full-employment value. Doing this is however misleading because it assumes that unions’ behaviour and bargaining are independent from globalization. If globalization has an impact on the conditions and results of union’s bargaining, then those new determinants and conditions must be considered when determining the bargaining outcomes in terms of wage and unemployment. The impact of openness and globalization on unionization and bargaining is surveyed by Rayp (2013). Dumont et al. (2006) presented a model in which a domestic firm takes as given the imports of the good it produces and bargains with a union over the domestic wage and employment (‘efficient bargaining’; see below). They then analyse the effects of globalization which consists in an increase in imports and a related reduction in the union’s bargaining power. The model leads to the conclusions that (i) globalization entails a fall in domestic employment which is magnified (tempered) if the union is wage-oriented (employment-oriented)3 and (ii) globalization normally entails a decrease in wages. We focus here on two types of approach. The first is the ‘union monopoly with right to manage’ model, in which the union decides for the wage by maximizing its utility function depending on wage and on employment and knows the reaction function (labour demand function) of the profit-maximizing firm which determines the hiring. The second is the ‘efficient bargaining’ model in which the employer and the union bargain on both the wage and employment.4 The union monopoly approach portrays a situation in which the union is powerful enough to impose the wage, but hiring keeps in the hands of the firm (‘right to manage’). It is representative of Nordic countries (also perhaps Germany) until the 1990s. The efficient bargaining model is characteristic of the way negotiating occurs in a number of multinational affiliates where both wages and employment are bargained because of the threat of relocating activities in other countries. This model determines an efficient (optimal) solution, but this solution is not an equilibrium, which means that employers have an ex post incentive not to comply with the agreement.

The union’s utility is U ðw, LÞ = ðw - wÞLα , with α > 1 ( 0. 2. Coefficient B decreases with time: B′ = ∂B/∂t < 0. This pictures the relocation to the South of productive capital (independently from wage). 3. The derivative Bw  ∂B/∂w decreases with time: Bw′ = ∂Bw/∂t < 0. This last feature means that the negative impact of an increase in wage on the amount of capital in the North is magnified with time, which is a logical result of the globalization-driven reduction in the cost of capital displacement. Both the increase in the elasticity ε and the decrease in B (productive capital outflows) lessen the wage (formal proofs in Appendix A). This reduction is reinforced by the amplification of the wage-related decrease in B (∂Bw/∂t < 0) and moderated by the backward effect of the decreasing wage on capital flows and hence B. The effect on northern unemployment is ambiguous. On the one hand, the relocation of production to the South (productive capital outflows entailing a decrease in B) reduces employment. On the other hand, the wage reduction tends to increase employment. The total effect then depends on the respective magnitude of relocation and wage reduction. Finally, it must be noticed that the relocation-driven decrease in B can be offset, or even reversed, by an increase in productivity due to globalization-induced technical progress and offshoring. Within a monopoly union framework, globalization leads to a reduction in wages, and this can come with a concomitant rise in unemployment. Consequently, the influence of trade unions decreases and this jeopardizes the unions’ power. But the monopoly union model corresponds to a situation in which the union power is large enough to impose the wage. With the decline in unions’ power, the relationship between unions and employers moves towards a bargaining model and, given the threat of lowering employment by relocating production to low-wage countries, the bargain typically concerns both wages and employment (‘efficient bargaining’). (b) Efficient Bargaining All the workers, employed or unemployed, are members of the union. A worker’s utility depends on her income and workers are risk-adverse. Hence, their utility is equal to ωβ where ω is the income and 0 < β < 1 measures the risk aversion. The union’s utility is the sum of its members’ utility V = wβ L þ wβ L - L = wβ L - U þ wβ U, where w is the real wage, w the unemployment subsidy, L the labour supply assumed inelastic, L the employed labour and

4.1

Labour Market Institutions and the Inequality-Unemployment Trade-Off

97

U = L - L the unemployment. The firm maximizes its profit (Y - wL) subject to the 1-α α L = ALα . The firm’s outside option π (profit when technology constraint Y = AK bargaining fails) is nil without globalization. The negotiation outcome is calculated from Rubinstein’s bargaining model (1982), with γ denoting the union’s bargaining power (and 1 - γ the employer’s bargaining power). Bargaining then determines the wage w and employment L (a hat indicates an equilibrium value). From those values, it is possible to calculate capital α income (profit π = AL - wL) and the ratio of the capital share on the income share ρ  π=wL. As capital is typically concentrated in a limited number of hands, the ratio ρ  π=wL can be seen as an indicator of inequality in income distribution. Those values without globalization (π = 0 ) are calculated in Appendix B, Section “Bargaining Without Globalization”. As expected, a rise in the union’s bargaining power γ increases the wage and reduces inequality (∂w=∂γ > 0 and ∂ρ=∂γ < 0). Let us now introduce globalization in this story. To simplify, we focus on a characteristic which is key in the bargaining approach: by allowing firms to relocate their productions in low-wage emerging countries, globalization changes the outside option by making the profit be non-nil if the negotiation fails. Hence, the firm’s outside option is now π > 0. In addition, we assume that globalization comes with an increase in π deriving from the fall in the cost of relocating production abroad. In the bargaining process, employers can now put forward the threat of relocating production abroad. This substantially changes the shape of negotiations. At the bargaining equilibrium, globalization (increase in π > 0 ) entails (see Appendix B, Section “Bargaining with Globalization”): 1. A decrease in the equilibrium wage w and in employment L. α 2. An increase in capital income (the firm’s profit π = AL - wL). 3. An increase in the capital income share in relation to the labour income share ρ = π=wL. By focusing on the sole impact of globalization on the firm’s outside option, the above analysis has shown that globalization makes the bargaining outcomes increasingly detrimental to the workers, i.e. to the union members. This typically renders union membership increasingly unattractive, reducing unionization and jeopardizing the union’s position in the negotiations with employers. In other words, the union’s bargaining power weakens. If we now add to the analysis a decline in the union’s bargaining power (decrease in γ), the above three results (decrease in wage and unemployment, increase in capital income and increase in the ratio of the capital share to the labour share) are magnified (Appendix B, Sect. B2). There is a last feature of the efficient bargaining model which deserves to be highlighted. The bargaining outcome is efficient, but it is not an equilibrium: the negotiated employment L is not the firm’s optimum for the negotiated wage w. Thus, the firm has an incentive to reduce employment below the bargained level, i.e. not to comply with the agreement ex post. The non-compliance is even reinforced by the long-lasting decrease in the cost of relocating production abroad which raises the

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related profit which can then move above the profit π resulting from bargaining. The last two decades testify of a tendency of MNFs’ affiliates to ex post deny agreements in which employment preservation had been bargained against wage moderation. (c) Empirical Evidence The impact of globalization on the unions’ bargaining power was estimated by Dumont et al. (2006) at the sector level for five European countries (Belgium, France, Germany, Italy and the UK). Based a theoretical model of bargaining with labour hoarding (Haskel & Martin, 1992), they firstly calculate the bargaining power of unions for each ISIC two-digit sector in the five countries over the period 1994–1998, and they concurrently diagnose the type of bargaining model which is the most consistent with their results. They subsequently regress the bargaining power on a set of determinants, among which two indicators of international trade competition, i.e. imports from emerging countries and from high-income countries. Their results show that: 1. The model of labour hoarding with bargaining over both wages and work effort is better tailored to picture-observed facts. 2. Unions are wage-oriented. 3. There is a significant negative impact of imports on the unions’ power, particularly imports from emerging countries. The estimates made by Dumont et al. (2006) can nevertheless be seen as imperfect measures of the impact of globalization for several reasons. First, the unions’ power is estimated in the period 1994–1998, i.e. at the initial stage of the present wave of globalization which begins in the early 1990s. If there is a lag between globalization and its effect on the unions’ power, which is likely, then only a part of this effect is measured by the authors’ estimates. The impact of globalization could thus be underestimated. Second, when considering the countries’ hierarchy, the estimated union’s bargaining powers are the opposite of the observed rates of unionization, whereas one should expect them to coincide.7 Abraham et al. (2009) analyse the impact of globalization upon both firms’ ‘price-cost’ margins and the union’s bargaining power for a Belgian panel of manufacturing firms. They find that imports, especially from emerging countries, lessen the union’s bargaining power. Using a panel dataset of Spanish manufacturing firms, in the period 1990–2005, Moreno and Rodriguez (2011) find that imports reduce the union’s bargaining power in the sectors of final and homogenous goods. From a panel of French manufacturing firms, Caselli et al. (2021) find that Chinese import competition strengthens firms’ position in income distribution, but this occurs by a rise in productivity rather than by a decrease in wages.

7 The mean of the sectoral unions’ powers estimated by Dumont et al. (2006, Table 1) is 0.73 for France, 0.6 for Germany, 0.46 for the UK and 0.29 for Italy, whereas the unionization rates are, respectively, for those countries 0.11, 0.25, 0.31 and 0.36 over the period 1994–1998 (see Fig. 1.31 in Chap. 1).

4.2

Progressivity-Redistribution Trade-Off, Middle-Class Curse and Social. . .

99

(d) Social Policies and the Bargaining Outcomes In both the monopoly union model and the efficient bargaining model, the bargained equilibrium wage directly depends on the unemployment subsidy which is the union’s outside option. This means that public social policies interfere with employer-employee bargaining to determine the wage and the related income distribution between capital and labour. A capital-oriented conservative government can reduce the subsidies paid to the unemployed and thereby lessen the bargained wage and presumably unemployment. A labour-oriented social democrat government can temper the impact of globalization by upgrading social transfers to the unemployed. Finally, the government can set new rules which lessen the union power. This is typically what occurred in the UK in the 1980s and in Germany in the 1990s.

4.2

Progressivity-Redistribution Trade-Off, Middle-Class Curse and Social Democracy Curse

This section is devoted to the analysis of the globalization-induced constraints on public levies and redistribution and on their effects on the middle class and on the political orientations and votes of the population.

4.2.1

Middle-Class Curse and the Progressivity-Redistribution Trade-Off

In Chap. 3, we have diagnosed that tax competition encourages governments to reduce the tax rates on both capital and income, generating a ‘race to the bottom’ which jeopardizes redistribution (Sect. 3.1.2). We also noticed that when the unit mobility cost does not increase with the tax base, the outflow of tax bases affects the top of the tax base distribution (Sect. 3.1.1). This typically means that to prevent the outflow of tax bases, the reduction of tax rates must concern the highest tax bases (high incomes, large wealth, etc.). We now extend the analysis by considering the impact of those constraints on redistribution policies and the middle class. If the governments want to compensate the globalization-induced losses suffered by low-skilled workers (‘compensation effect’) and if globalization entails a decrease in the taxes paid by high incomes (tax competition), the financing of redistribution must move from the richest households to the middle class. In other words, globalization indirectly hurts the middle class by displacing the tax burden from the high incomes to the middle incomes. This ‘middle-class curse’ has been highlighted in a number of works (e.g. Simula & Trannoy, 2005, 2010, 2012; Hellier, 2021).

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Hellier (2021) extends this finding by putting forward a globalization-driven trade-off between income tax progressivity and redistribution which constrains the governments’ anti-inequality policy. The rationale of this trade-off is as follows. If governments want to maintain (or increase) redistribution, they must displace the tax burden from the top incomes to the middle incomes, which lessens tax progressivity. If the governments want to oppose the decrease in tax progressivity, they must reduce all tax rates in proportion to the reduction in the top rates due to tax competition, and this general tax cut lessens redistribution. It must be stressed that: 1. The reduction in the tax rates on top incomes expands with time. This shows that progressivity typically declines anyway; the preserving of redistribution only reinforces this tendency. 2. As North-South trade and offshoring increasingly compress the unskilled workers wages and raise their unemployment risks, the need to compensate those losses tends to increase the taxation of the middle incomes and thereby to reinforce the progressivity-redistribution trade-off. Finally, the progressivity-redistribution trade-off induces a clear limitation to anti-inequality policies because the combination of tax progressivity and redistribution was a key instrument in the hand of policy-makers to reduce inequality since (i) tax progressivity permitted to lessen the after-tax incomes at the top, (ii) redistribution allowed increasing incomes at the bottom and (iii) the former financed the latter.

4.2.2

Social Democracy Curse and the Rise of Populism

The mobility of top tax bases generates a progressivity-redistribution trade-off. This trade-off jeopardizes the political position of social democracy (Hellier, 2021). It also reinforces the attractiveness of populist parties. (a) Social Democracy Curse The combination of tax progressivity and redistribution was the core of social democratic policies after the World War II period until the 1980s. In fact, such a policy permitted to realize an implicit alliance between the lower and the middle class. The former gained extra incomes, free access to education and health and thereby a possibility to go up the social ladder and join the middle class. The latter gained a reduction in its income gap and wealth gap with the upper class and an increase in its weight in the society and also benefited from cheap educational and health services, with a higher probability to enter the upper class. This implicit alliance is broken by the progressivity-redistribution trade-off which makes the interests of the middle class and the lower class to diverge because preserving redistribution for the modest households now implies to increase the tax burden on the middle class.

4.2

Progressivity-Redistribution Trade-Off, Middle-Class Curse and Social. . .

101

The decline in the political influence of social democracy is confirmed by the calculations of Benedetto et al. (2020). Considering votes for social democracy in the total electorate for 31 countries, they show that their weight fluctuated around 25% from the early 1950s to the mid-1980s. This weight has subsequently continuously declined to attain less than 15% in 2017. (b) The Rise of Populism The decline of social democracy has come with a rise of populist parties which has been a common tendency in a majority of advanced economies over the last 20 years. Donald Trump’s election in the USA, the Brexit in the UK, the votes in favour of the Front National (now Rassemblement national) in France and the participation or support of extreme-right parties to governments in Austria, the Netherlands, Belgium, Italy, Denmark, Finland and Sweden are clear indications of the expansion of populism in old democracies. In their survey on populism, Guriev and Papaioannou (2021) highlight that the most basic definition of populism (the trait found in all the definitions and studies) is the division of the society between the ‘pure’ people and the ‘corrupted’ elite. In the present wave of populism, this anti-elite characteristic is typically directed against the ‘globalized’ elite. For Guriev and Papaioannou, anti-globalization (and anti-European Union) is one of the five major features defining modern populism. The pro-populism dynamics is nurtured by (i) the fact that low-skilled and middleskilled workers are the main losers of globalization; (ii) the richest (top 1%, top 0.1%) are the major winners; (iii) the traditional political parties, conservative and socialdemocrat, have accompanied globalization by fostering trade openness and tax cuts; and (iv) the emergence of a globalized elite (CEOs, international ‘experts’, businessmen, sports(wo)men, singers, actors/actresses, international ‘bureaucrats’, etc.). The empirical literature clearly confirms the positive impact of globalization on populism and on the votes in favour of populist parties and candidates. As the rising share of the South in international trade is essentially attributable to China (Chap. 1, Fig. 1.2), several studies have investigated the impact of the Chinese shock upon the extension of populism. In the case of the USA, Autor et al. (2020a, b) have shown that the competition from China has significantly changed TV preferences of the people in favour of Fox News, increased the right-wing ideology among the white population and had a sizeable pro-Trump impact in the 2016 presidential election. Analysing 15 Western European countries, Colantone and Stanig (2018a) showed that Chinese import competition boosts the votes in favour of populist (nationalist, far-right and anti-EU) parties. The effect of import competition (from China, emerging countries and/or central European countries) on the votes in favour of populist and extreme-right parties are also found at the country level for the UK (Colantone & Stanig, 2018b, on the impact in favour of the Brexit), Germany (Dippel et al., 2018), Italy (Barone & Kreuter, 2019; Caselli et al., 2020) and France (Malgouyres, 2017). Studying 15 Western European democracies in the period 1990–2018, Milner (2021) finds that globalization, particularly trade, has increased the support for populist extreme-right parties and that social compensation is unable to counteract this support. From a large study of 628 elections in 55 countries over 60 years, Docquier

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et al. (2022) find that trade increases the votes in favour of populist parties when it hurts unskilled workers, i.e. when imports of unskilled-intensive goods increase.

4.3

Public Deficit and Debt

In Chap. 1, we have noticed that globalization has been accompanied by an increase in public debts. Azzimonti et al. (2014) develop a model in which financial globalization leads to an increase in public debts. The rationale of the explanation is as follows: Globalization entails (i) an integration of financial markets and (ii) an increase in the volatility of privately uninsurable incomes (idiosyncratic risks). Because of financial integration, the elasticity of the interest rate in relation to each single country demand for credit (national supply of debt) decreases.8 When there is no policy coordination, this fosters public borrowing and debt. Concurrently, there is an increase in public spending to respond to idiosyncratic risks. Hence, both components of globalization tend to increase public spending and debt. From a more general point of view, there are four major reasons for globalization to raise public debt: 1. The increase in inequality and in social risks entails an additional demand for redistribution and compensation from the low and middle incomes. 2. Tax competition prevents the funding of compensation by taxes on firms’ profits and high incomes. 3. Pro-redistribution governments are reluctant to displace the tax burden on the middle class because it jeopardizes their political position. 4. International financial liberalization and integration lessen the cost of debts. The increase in public debt is nevertheless not unlimited for the usual reason of sustainability. In addition, the international funding of public debts tends to increase the international financial markets’ pressure on governments’ policies.

4.4

Globalization, Education and Inequality

The distinction between skilled and unskilled workers is crucial for the analysis of the effect of trade on inequality. In advanced countries, the impact of North-South trade and offshoring on inequality and employment is all the greater as the proportion of low- and middle-skilled workers is high (see Chap. 2). A direct consequence of this feature is that the decrease in this proportion could reduce both inequality and unemployment. In the middle and longer terms, the population’s skill typically depends on education. A central question is then to know if globalization fosters

8

On this mechanism, see also Chang (1990).

4.4

Globalization, Education and Inequality

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or hampers education and skill upgrading. In this respect, two opposite effects can be distinguished. On the one hand, trade-driven increase in the skill premium encourages individuals to educate and fosters skill upgrading in the North (the ‘incentive effect’). On the other hand, both (i) the decrease in low-skilled families’ income and (ii) the rising cost of education (because it utilizes skilled labour) hinder skill accumulation when education is costly and the credit market is imperfect.

4.4.1

The ‘Incentive Effect’

Findlay and Kierzkowski (1983) were the firsts to model the impact of North-South trade on education in both the North and the South. They introduced human capital accumulation into a North-South Heckscher-Ohlin model with skilled and unskilled labour. As usual in HOS models, openness increases the return to the relatively abundant factor in each area. Hence, skilled relative wage increases in the North and unskilled relative wage in the South. This fosters education and human capital accumulation in the North and hinders them in the South. Hence, in advanced countries, globalization releases in the longer term its short-term pro-inequality bias. Findlay and Kierzkowski’s approach has subsequently been extended by introducing supplementary assumptions. By adding differences in abilities among individuals, Borsook (1987) showed that openness promotes education but increases inequality in the North. The concomitance of trade-induced skill upgrading and inequality can also be found in Grossman and Helpman (1991), Janeba (2003) and Falvey et al. (2010). In the case of a small open economy, Janeba (2003) shows that import competition increases inequality when considering skill endowment as given (the ‘direct effect’), but the incentive to educate due to higher return to skill goes in the opposite direction (the ‘indirect effect’). Falvey et al. (2010) model a small economy in which (i) individuals have different abilities and can educate themselves throughout their working lives, (ii) the education activity utilizes skilled labour and time and (iii) trade liberalization can be anticipated or not anticipated. Anticipated trade liberalization improves the situation of educated workers except those with a low ability. Trade liberalization can thus increase both the skill level of the population and inequality. Within an overlapping generation model with skill accumulation and North-South trade, Borissov and Hellier (2013) distinguish large trade shocks (emergence of a large South) and small trade shocks (small South). They find that a large shock boosts education and increases the proportion of skilled workers but not a small shock. Assuming (i) a large number of small countries, (ii) heterogeneous workers and (iii) between-country divergence in skill augmenting technology, Auer (2015) finds that trade generates discrepancies in human capital accumulation and favours the countries which are well endowed with high-skilled labour. Dinopoulos and Segerstrom (1999) present a general equilibrium model in which rising inequality is explained by North-North trade. Openness boosts both the skill-intensive R&D activity and skill acquisition, increasing the skill premium and inciting more individuals to get educated.

104

4.4.2

4

Anti-inequality Policies and Globalization

The ‘Cost of Education’ Effect

The models presented in Sect. 4.4.1 are based on the incentive effect, i.e. the increase in skilled workers’ relative wage (the return to education) fosters education. In the opposite direction, a number of works show that trade can hinder human capital accumulation in the North (e.g. Cartiglia, 1997; Eicher, 1999). Two elements explain the trade-induced barriers to education: 1. As the education activity essentially utilizes skilled labour, the cost of education increases when trade raises the skilled wage. 2. This negative cost effect is magnified when market imperfections make the access to credit difficult for families with low income (Cartiglia, 1997) because NorthSouth trade lessens the unskilled families’ incomes (see Chap. 2). Ranjan (2001) shows that trade liberalization could nevertheless increase human capital accumulation in the North when credit market imperfections are sufficiently low.

4.4.3

Total Effect and Policy Implications

Appendix C presents a simple synthetic model of human capital accumulation with globalization (see also the more general presentation in Hellier, 2023b). Individuals are defined by their personal ability and their cultural family background, and they decide to get educated or not depending on the return to education. Both ability and family background increase the efficiency of education. There is a cost of education, and the individuals borrow in the credit market with their parents’ guarantee to pay this cost. The credit market imperfection makes that the interest rate is higher for low-paid unskilled families than for skilled families. Finally, globalization, particularly North-South trade, increases the real return to education and lessens the unskilled wage paid to non-educated workers. This synthetic model generates to the following results: 1. In the case of children from skilled (educated) families, both the incentive effect and the cost of education effect increase the net return to education. Globalization increases the skilled real wage and reduces the unskilled real wage, boosting thereby the incentive to education. For individuals from skilled families, the increase in the cost of education services is offset by the identical increase in their pay (both proportional to the wage per unit of skill), whereas the interest rate paid on credit deceases because of the rise in skilled wages. Since both the incentive effect and the cost of education effect boost education, the number of children born in educated families who select education increases, as well as their educational level (human capital). 2. Globalization can raise or reduce the number of children from unskilled families who select education. For those children, the incentive effect encourages

4.4

Globalization, Education and Inequality

105

education as for those born in skilled families. In contrast, the education cost effect reduces the motivation to education because both the price of educational services and the cost of borrowing (interest rate) increase. Then, the number of individuals born in unskilled families who select education increases if the incentive effect prevails, and it decreases if the education cost effect prevails (the formal condition is exposed in Appendix C). Note that even when the number of educated children from unskilled families augments, this is at a lower rate than for children from skilled families. In addition, the globalizationdriven rise in education cost reduces the educational level (human capital) of all educated individuals born in unskilled families. 3. Consequently, globalization amplifies the advantage of children from skilled families in the access to education. First, their weight in the set of educated individuals increases. Second, their human capital increases, whereas that of children from unskilled families shrinks. There is thus an enlargement of the educational gap between the educated individuals born in skilled families and those born in unskilled families. Globalization supports the maintenance of children from skilled families in the group of skilled workers and restrains education for children born in unskilled families. This reduces intergenerational mobility and reinforces the intergenerational skill persistence. In addition, the ‘Great Gatsby Curve’ (see the review article by Durlauf et al., 2022) which displays a negative relationship between inequality and intergenerational mobility suggests that globalization can hamper social mobility between generations if it increases inequality. Consequently, globalization could foster inequality both in the short and in the longer term, except when the incentive effect is prevailing. In summary, globalization can hamper skill upgrading and support educational inequality in two ways. First, it can discourage the education of children from unskilled families when the cost of education effect is sufficiently large compared to the incentive effect. Second, it expands the educational difference between the educated individuals born in skilled families and those born in unskilled families. By lessening intergenerational mobility, globalization typically tends to improve the educational position of children from skilled families compared to children from unskilled families. A first way to counteract those damages could be to increase public expenditures on education. However, as increasing the per-student expenditure fosters the pro-education decision of all individuals, such a policy does not fill the gap between skilled and unskilled families generated by globalization. The only way to fill this gap is to favour extra expenditures for the sole children from low-income families, i.e. an ‘affirmative action’ policy. A second policy permitting to offset the unskilled families’ disadvantage consists in erasing the risk premium they pay by providing a public insurance or support on their loans taken out for education. Note that to equalize the interest rates for all borrowers, the public authority should select the interest rate paid by the household with the highest income.

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The above results were determined by assuming that individuals borrow to pay the education cost. Assume now that the cost of education is paid by altruistic pro-education parents and that the parents’ expectations for their children’s education increase with the parents’ skill. This modifies the model by making the individuals’ education to depend directly on their parents’ funding decision linked to their income and skill. Parents with high skill and incomes pay more for their children’s education both because they earn more and because they expect a higher education level of their offspring. Here again, globalization favours education in the skilled families because it pushes up the skill premium. The provision of scholarships to the students from low skill and low-income families could permit to counteract this pro-skilled family educational bias. A complete offset of this bias is nevertheless unlikely because the increase in top incomes and the educational advantage of the children from those families are substantial. Finally, all the policies compensating the globalization-induced education losses of unskilled families suppose extra social expenditures to fund affirmative actions in favour of less-skilled and low-income households. Tax competition and the related cuts in high-income taxation can hamper the setting of those policies.

4.5

Major Lessons on Globalization and Anti-inequality Policies

The analyses presented in Chap. 4 reveal the following major results as regards the impact of globalization on the efficiency and feasibility of anti-inequality policies: 1. Confronted to the globalization-driven tax competition and changes in labour demands, governments can either let market adjustment operate and reduce redistribution (the ‘efficiency effect’), which leads to rising inequality, or intervene to compensate the so-generated social damages (the ‘compensation effect’). 2. When governments decide to compensate the globalization-driven rise in inequality by policies which hinder wage adjustment by maintaining the unskilled workers’ wage above its full-employment level, this generates an inequalityunemployment trade-off which constrains those policies. 3. To offset the cuts in the taxation of high incomes linked to tax competition, governments must increase the tax burden of the middle incomes, generating thereby a ‘middle-class curse’. 4. Tax competition generates a trade-off between tax progressivity and redistribution. As the tax rates on high incomes must decrease, all tax rates should decrease proportionally if governments do not want to reduce tax progressivity. This hinders redistribution. If governments want to maintain redistribution, they must increase the levies on the middle incomes and reduce thereby tax progressivity. 5. The middle-class curse and the progressivity-redistribution trade-off tend to oppose the policy goals of the middle class which rejects the rise in taxes and

Appendices

107

the goals of the lower class which supports the rise in taxes to finance redistribution. This opposition jeopardizes the political position of the social democracy which was based on an implicit agreement of the middle class and the lower class on redistribution paid by the upper class. 6. The opposition to globalization and the reject of the globalized elite tend to foster the rise of populism which is observed in all advanced countries. 7. When governments are reluctant to increase the tax burden of the middle class, they can fund redistribution by public deficits and debt, even if this policy is limited because it is not sustainable in the long term. Globalization fosters public deficits and debt through financial liberalization and international financial integration. 8. By raising inequality, globalization has an impact on education decisions, on human capital accumulation and finally on the countries’ skill endowments. Inequality has two opposite impacts on education. It firstly encourages education by raising the skill premium (incentive effect), but it also hampers education by raising its cost and making its financing difficult for low-paid households (cost effect). When the cost effect prevails, skill upgrading is hindered. In all cases, globalization-induced rising inequality favours high-skilled and rich families and lessens intergenerational mobility.

Appendices Appendix A: The Monopoly Union Model The union maximizes its utility U = wL þ w L - L subject to the firm’s labour demand L = B(w) × w-ε, ∂B/∂w < 0. This determines the following wage: w=

ðw - wÞw Bw ε wþ ε-1 B ε-1

ð4:A1Þ

If Bw = 0, i.e. without globalization, w = ε -ε 1 w. With globalization (Bw < 0), the wage is smaller than without globalization. Relation (4.A1) defines the quadratic equation - BBw w2 þ ðε-1þBw w=BÞw-εw=0. By differentiating this equation, we can analyse the effects on the bargained equilibrium wage of the globalization-driven increase in the elasticity ε and decrease in B and Bw: ∂w w-w 0 ∂B ε - 1 þ Bw 2 B - 2 ðw - wÞw þ Bw B - 1 ðw - 2wÞ

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Anti-inequality Policies and Globalization

B - 1 ðw - wÞw ∂w = >0 1 ∂Bw ε - 1 þ Bw B ðw - 2wÞ þ Bw 2 B - 2 ðw - wÞw The three components of globalization

∂ε ∂t

> 0,

∂B ∂t

< 0,

∂Bw ∂t

< 0 reduce the

wage.

Appendix B: The Efficient Bargaining Model The assumptions of the model are (explanations in Sect. 4.1.2): 1-α

The production function: Y = AK Lα = ALα β The union’s objective: V = w L þ wβ L - L The union’s outside option: wβ L The firm’s objective: π = Y - wL The union’s bargaining power: γ, 0 ≤ γ ≤ 1 The price of the good is unit, so that all variables are expressed in real terms. The firm’s outside option depends on whether the economy is globalized or not.

Bargaining Without Globalization Without globalization, the firm’s outside option is π = 0. The programme determining the Nash bargaining equilibrium is: w, L = arg max ALα - wL w, L

1-γ

γ

wβ - wβ L , ALα - wL ≥ 0, w ≥ w , L ≤ L:

 α - wL þ γ ln ðmax Z = ð1 - γ Þ ln AL w, L þ γ ln LÞ and determining the optimum yield:

Rewriting the programme in log wβ - wβ

1 ∂Z αALα - 1 - w þ γ =0 , = ð1 - γ Þ L ∂L ALα - wL

1-γ ALα - wL =γ αALα - wL w = ðα þ ð1 - αÞγ ÞALα - 1 β-1

∂Z L βwβ - 1 = - ð1 - γ Þ α =0 , þγ β w - wβ ∂w AL - wL

α

AL - wL 1 - γ βw = γ ðwβ - wβ ÞL ð1 - γ Þ wβ - wβ w þ = Lα - 1 A γβwβ - 1 A

ð4:B1Þ ð4:B2Þ ð4:B3Þ ð4:B4Þ

Appendices

109

(4.B2) and (4.B4): 1=β

α þ ð1 - αÞγ α þ ð1 - βÞð1 - αÞγ

w=

ð4:B5Þ

w

(4.B2) and (4.B5): α þ ð1 - βÞð1 - αÞγ L= ðα þ ð1 - αÞγ Þ1 - β

1=βð1 - αÞ

A w

1=ð1 - αÞ

ð4:B6Þ

The labour share (wL=Y) is (from 4.B2): wL=Y = α þ ð1 - αÞγ

ð4:B7Þ

The capital income share (π=Y, π = Y - wL) and the ratio ρ  π=wL of capital income to labour income are: π=Y = ð1 - αÞð1 - γ Þ

ð4:B8Þ

ð1 - αÞ - ð1 - αÞγ α þ ð 1 - αÞ γ

ð4:B9Þ

ρ= It can be easily verified that:

1. The wage increases with the union’s bargaining power (∂w/∂γ > 0). 2. Employment increases with the union’s bargaining power (∂L/∂γ > 0) when β < 1. 3. The labour share increases with the union’s bargaining power. 4. The capital income share decreases with the union’s bargaining power. 5. The ratio of the capital to the labour income decreases with the union’s bargaining power. Finally, it can be noted that L is not the firm’s optimum for w = w: max π = ALα - wL, s:t: : w = w = L

α þ ð1 - αÞγ α þ ð1 - βÞð1 - αÞγ

1=β

w

At the firm’s optimum: ∂π αA =0 ) L= w ∂L

1=ð1 - αÞ

=

α þ ð1 - βÞð1 - αÞγ ðα þ ð1 - αÞγ Þ1 - β

1=βð1 - αÞ

αA w

1=ð1 - αÞ

1

= α1 - α L < L

Hence, the firm is ex post incited not to comply with its commitment.

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Anti-inequality Policies and Globalization

Bargaining with Globalization Globalization makes the firm’s outside option be π > 0, with π increasing with time. The related programme determining the Nash equilibrium of bargaining is: max Z = ð1 - γ Þ ln ALα - wL - π þ γ ln wβ - wβ þ γ ln L w, L This programme leads to the following results: αALα - 1 - w ∂Z 0 1 þγ ¼0 ¼ ð1 - γ Þ α L ∂L AL - wL - π

,

1-γ ALα - wL - π ¼ γ αALα - wL

ð4:B10Þ

w ¼ ðð1 - γ Þα þ γ ÞALα - 1 - γπ=L

ð4:B11Þ

ð1 - γ ÞL ∂Z 0 γβwβ - 1 ¼ - α ¼0 þ β ∂w AL - wL - π w - wβ

,

α 1 - γ βwβ - 1 AL - wL - π ¼ γ ðwβ - wβ ÞL

ð4:B12Þ

ð1 - γ þ γβÞw ð1 - γ Þwβ w1 - β π þ ¼ ALα - 1 γβ γβ L

ð4:B13Þ

(4.B13) in (4.B11): α þ ð1 - αÞγ w= α þ ð1 - αÞð1 - βÞγ þ γβαπ=wL

1=β

w

ð4:B14Þ

Inserting (4.B11) in π = ALα - wL yields π = ð1 - γ Þð1 - αÞALα þ γπ and thus: α

ð1 - αÞ - ð1 - αÞγ þ γπ=AL π = ρ= α wL α þ ð1 - αÞγ - γπ=AL

ð4:B15Þ

The firm’s outside option π > 0 reduces the wage and increases the capital share at the expense of the labour share compared to the case with no globalization (π = 0). Combining (4.B10) and (4.B12), we obtain: L = Aβα

1=ð1 - αÞ

wβ w1 - β - ð1 - βÞw

- 1=ð1 - αÞ

ð4:B16Þ

Appendices

111

By inserting (4.B16) in (4.B14): α

β

ðα þ ð1 - αÞð1 - βÞγ Þw þ

γπ wβ w1 - β - ð1 - βÞwαþð1 - αÞβ A

1=ð1 - αÞ

1 1-α

ðβαÞα=ð1 - αÞ

- ðα þ ð1 - αÞγ Þwβ = 0

ð4:B17Þ

Differentiating (4.B17): -1

∂w ¼ ∂π

ðα þ ð1 - αÞð1 - βÞγ ÞðβαÞ ðw=wÞβ - ð1 - βÞ

α 1-α

1 1-α

1 1-α

γA

þ

1

w1 - α

ðw=wÞβ - ð1 - βÞ þ β=α αð1 - βÞw ð1 - αÞ ðw=wÞβ - ð1 - βÞ

π

As ðw=wÞβ - ð1 - βÞ > 0, ∂w < 0. A rise in the outside option π entails a decrease ∂π in wage. Inserting (4.B14) in (4.B11) yields: α þ ð1 - αÞγ γπ ðw=wÞβ - ð1 - βÞ ðw=wÞβ - ð1 - βÞ 1=ð1 - αÞ βα Aβα

1 1-α

α

w1 - α - 1 = 0

ð4:B18Þ Differentiating (4.B18) yields: ð1 - αÞ wβ w1 - β - ð1 - βÞw ∂w ¼ γπ ∂γ βα þ ðα þ ð1 - αÞγ Þð1 - βÞ 1 - ðw=wÞβ þ 1

1

α

ð1 - αÞA 1 - α ðβαÞ1 - α

ðwβ w1 - β - ð1 - βÞwÞ1 - α

As ðw=wÞβ - ð1 - βÞ > 0, ∂w > 0. An increase in the union’s bargaining power γ ∂γ entails an increase in wage. Equation (4.B16) determines all the couples of bargaining outcomes w, L consistent with all the couples ðγ, π Þ at the equilibrium. All those w, L such that w > w and L ≤ L draw the ‘contract curve’. From Eq. (4.B16), it can be straightforwardly calculated that employment increases with wage in the curve of contract (this curve us upward sloped: ∂L/∂w > 0).9 The equilibrium bargained employment L is determined on the curve of contract (4.B16) by the value w defined either by (4.B17) or by (4.B18). Consequently:

9

L = Aβα w β w

1 1-α

wβ w1 - β - ð1 - βÞw

< 1 and ðw=wÞβ - ð1 - βÞ > 0

- 1 -1 α

1

∂L ) ∂w =

ð1 - βÞðAβαÞ1 - α 1 - ðw=wÞ ð1 - αÞð

wβ w1 - β

- ð1 - βÞwÞ

β

2-α 1-α

;

∂L ∂w

>0

because

112

4

Anti-inequality Policies and Globalization

1. A rise in the outside option π entails a decrease in employment (since it reduces w). 2. An increase in the union’s power increases employment (since it raises the wage w). α

The profit of the firm (capital income) is π = AL - wL and according to (4.B16): 1

α

π = A1 - α ðβαÞ1 - α wβ w1 - β - ð1 - βÞw

- 1 -α α

- βαA

1 1-α

wβ w1 - β - ð1 - βÞw

- 1 -1 α

w

ð4:B19Þ Equation (4.B19) can be considered as drawing the contract curve in terms of wage and profit, i.e. the set of all the couples of bargained equilibria ðw, π Þ consistent with all the couples ðγ, π Þ and such that w > w and π > π. In this curve, the profit decreases with the wage value:10 þ

þ 1 1-α

1 - ðw=wÞβ ð1 - βÞ βαA ∂π ¼ 1 ∂w ð1 - αÞðwβ w1 - β - ð1 - βÞwÞ1 - α

þ

1-α ð1 - βÞ 1 - ðw=wÞβ

þ

1 1 þ ðw=wÞβ - ð1 - βÞ β

< 0

Since an increase in the firm’s outside option π entails a decrease in the equilibrium bargained wage (Eq. 4.B17), an increase in π induces an increase in the profit (capital income). In summary, a globalization-driven increase in the firm’s outside option π (profit in case of relocation of production abroad) entails: 1. 2. 3. 4.

A decrease in the equilibrium bargained wage w. A decrease in the equilibrium bargained employment L. An increase in capital income (profit) π. An increase in the ratio of the capital share to the income share (ρ = π=wL).

The same reasoning as that presented for the impact of an increase in the outside option can be made for the analysis of a decrease in the union’s bargaining power γ (by putting together ∂w/∂γ > 0 as defined by 4.B18 and ∂L/∂w > 0 and ∂π/∂w < 0 resulting from the contract curves 4.B16 and 4.B19). Then, a reduction in the union’s bargaining power γ entails: 1. 2. 3. 4.

10

A decrease in the equilibrium bargained wage w. A decrease in the equilibrium bargained employment L. An increase in capital income (profit) π. An increase in the ratio of the capital share to the income share (ρ = π=wL).

β

ðw=wÞ

1 - ð1 - βÞ

-

1 β

> 0 , ðw=wÞβ - 1 < 0, which is always true since w < w.

Appendices

113

Appendix C: Impact of Globalization on Education Consider ‘individual (i,t)’ belonging to dynasty (family) i at generation t. Individual (i,t) is fully defined by two elements, her/his personal ability ait and her/his parents’ cognitive human capital hit - 1. There are two periods in one individual’s life, education time and working time. Education provides cognitive human capital. If individual (i,t) decides to be educated, her/his cognitive human capital at the end of education time, hit, is given by relation: hit = δG × ait × eit ε × ð1 þ hit - 1 Þη

ð4:C1Þ

where δG is the public per-student expenditure in education, eit the quantity of educational services paid by the individual and ε, 0 < ε < 1, the elasticity of human capital formation with respect to eit. The price of education services is the wage per unit of skill wH, which indicates that the production of those services utilizes skilled labour. Being young, the individual must borrow to pay education services. Then, the individual’s cost of education expressed in the period of work is (1 + rit)wHeit, where rit is the interest rate paid by individual i. When educated, individual (i,t)‘s wage when she/he works is wHhit. If not educated, the individual has no cognitive human capital (hit = 0) and one unit of simple work and is paid wL. Imperfect competition makes the interest rate rit to decrease with the parents’ income wit - 1,with wit - 1 = wHhit - 1 if the parents are skilled and wit - 1 = wL if they are unskilled. This depicts the fact that (i) parents are loan guarantors and (ii) the lower the parents’ income, the higher the risk. Denoting Rit = 1 + rit, we can thus write: Rit = Rðwit - 1 Þ,

∂R < 0: ∂wit - 1

Consequently,Rit = R(wHhit - 1) for children with skilled parents and all children from unskilled families pay the same (highest) borrowing cost RL = R(wL). If individual i decides to be educated, she/he defines her/his optimal demand for educational services eit by maximizing the net return to education Iit = wHhit RitwHeit, subject to the human capital formation function (4.C1). The so-determined optimal demand for education services eit , the related human capital hit and net return to education I it are: eit = εδG ait ð1 þ hit - 1 Þη Rit - 1

1=ð1 - εÞ

ð4:C2Þ

114

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Anti-inequality Policies and Globalization

hit = ðεε δG ait ð1 þ hit - 1 Þη Rit - ε Þ

1=ð1 - εÞ

I it = wH 1 - ε1=ð1 - εÞ ðδG ait ð1 þ hit - 1 Þη Rit - ε Þ

ð4:C3Þ 1=ð1 - εÞ

ð4:C4Þ

The individual decides to get educated if the net return to education I it is higher than the net return of non-education wL. After re-arranging, inequality I it > wL can be written: ait ð1 þ hit - 1 Þη >

ðwL =wH Þ1 - ε Rit ε  θðwH , wL , Rit Þ ð 1 - εÞ 1 - ε ε ε δ G

ð4:C5Þ

Relation (4.C5) defines the condition for an individual with the characteristics (ait, hit - 1) to choose education. The expression ait(1 + hit - 1)η defines individual (i,t) by her/his family background hit - 1 and ability ait. The individual decides to get educated if ait(1 + hit - 1)η is higher than the value θ which depends on the wages wL and wH, on the cost of borrowing (personal interest rate) rit and on public expenditure on education δG. Note that for an individual born in an unskilled family, Condition (4.C5) is: ait >

ðwL =wH Þ1 - ε RðwL Þε  θðwH , wL Þ ð 1 - εÞ 1 - ε εε δ G

ð4:C5 ′ Þ

Globalization, particularly the expansion of North-South trade, leads to an increase in the real wage wH and to a decrease in the real wage wL. If γ is an indicator of globalization, we thus have ∂wH/∂γ > 0 and ∂wL/∂γ < 0. The increase in γ modifies condition (4.C5) in two ways: 1. Directly, by decreasing θ because wH/wL rises. 2. Indirectly because the changes in the parents’ wages modify the interest rates Rit. To analyse the impact of NST upon education and skill accumulation, we firstly calculate the derivative of θ with respect to the globalization indicator γ. The derivative (4.C6) reveals a wage effect and a borrowing cost effect:

∂θ ∂wL ∂wH ∂R ∂wit - 1 = θ ð1 - εÞwL - 1 - ð1 - εÞwH - 1 þ εRit - 1 ∂γ ∂wit - 1 ∂γ ∂γ ∂γ Wage effect

ð4:C6Þ

Borrowing cost effect

As ∂wH/∂γ > 0 and ∂wL/∂γ < 0, the wage effect always lessen θ, relaxing thereby the condition (4.C5) and increasing the number of individuals who select to educate themselves. The borrowing cost effect depends on whether the individual comes from a skilled or an unskilled family.

Appendices

115

If the parents are skilled, their income goes up and the interest rate on their loan decreases. Then, both the wage effect and the borrowing cost effect relax the condition for selecting education (Eq. 4.C7), and more children from skilled families get into education:

∂wH ∂θ ∂wL ∂wH ∂R þ εRit - 1 hit - 1 × - ð1 - εÞwH - 1 = θ ð1 - εÞwL - 1 ∂γ ∂γ ∂γ ∂γ ∂wit - 1 Wage effect < 0

ð4:C7Þ

Borrowing cost effect < 0

In addition, the decrease in the interest rate rit increases the education spending and the human capital of children from skilled families (Eqs. 4.C2 and 4.C3). In the case of unskilled families, the left-hand side of the condition for education (Eq. 4.C5) only depends on the individual’s ability and its right-hand side on wages. Only the individuals with an ability ait > θ(wH, wL) select education. The derivative (4.C6) can then be written:

∂θ =θ× ∂γ

∂wL ∂wH ∂R ∂wL - ð1 - εÞwH - 1 þ εRL - 1 × ∂wL ∂γ ∂γ ∂γ

ð1 - εÞwL - 1

Wage effect < 0

ð4:C8Þ

Borrowing cost effect > 0

The decrease in the unskilled wage wL increases the credit risk and hence the interest rate. This raises the unskilled families’ borrowing cost and strengthens the severity of condition (4.C5) by increasing θ. Hence, for children born in unskilled families, the wage effect and the borrowing cost effect go in opposite directions. To know which effect prevails and thereby if the number of educated children from unskilled families increases or decreases, this depends on the globalization elasticities of wages and on the wage elasticity of the interest rate. The condition for globalization to lower the number of children from unskilled families who select education is11:

11

∂θ ∂γ

> 0 , ð1 - εÞ

∂wH =wH ∂w =w ∂R=R ∂wL =wL - ð1 - εÞ L L < ε , 1 -ε ε  ∂γ=γ ∂γ=γ ∂wL ==wL ∂γ=γ -

þ

∂wH =wH ∂wL =wL = -1 ∂γ=γ ∂γ=γ þ

, -

>

-

∂R=R ∂wL ==wL -

-

∂R=R ∂wL ==wL

-

>

1-ε ε

-

∂wH =wH ∂γ=γ

L =wL = ∂w∂γ=γ þ 1 , ηR=wL >

1-ε ε

ηwH =γ ηwL =γ

þ1 .

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4

ε × ηR=wL > ð1 - εÞ with ηR=wL = -

∂R=R ∂wL =wL

Anti-inequality Policies and Globalization

ηwH =γ þ1 ηwL =γ

ð4:C9Þ ∂wH =wH ∂γ=γ L =wL - ∂w∂γ=γ

the wage elasticity of the interest rate, ηwH =γ =

the

elasticity of the skilled wage with respect to globalization and ηwL =γ = the elasticity of the unskilled wage with respect to globalization. Equation (4.C9) stipulates that globalization lessens the number of educated children from unskilled families when the borrowing cost effect ε × ηR=wL dominates the wage effect ð1 - εÞ

ηwH =γ ηwL =γ

þ1

for. Rewriting (4.C9) in the form ε × ηR=wL ×

ηwL =γ > ð1 - εÞ ηwH =γ þ ηwL =γ shows that this corresponds to the cost of education effect ε × ηR=wL × ηwL =γ dominating the incentive effect ð1 - εÞ ηwH =γ þ ηwL =γ . Finally, Eq. (4.C3) shows that globalization makes all the children from unskilled families who get educated (those with an ability ait > θ(wH, wL)) to lessen their optimal human capital because of the increase in the interest rate. In summary, globalization entails: 1. An increase in the number of children from skilled families who select education. 2. An increase of the educational level (human capital) of all the educated children from skilled families. 3. An increase in the number of children from unskilled families who select education if ε × ηR=wL < ð1 - εÞ ð 1 - εÞ

ηwH =γ ηwL =γ

ηwH =γ ηwL =γ

þ1

and a decrease

if ε × ηR=wL >

þ1 .

4. A decrease of the educational level (human capital) of all the educated children from unskilled families. 5. An enlargement of the skill gap between the individuals born in skilled families and those born in unskilled families and a reduction in intergenerational skill mobility. Increasing the public expenditure on education δG permits to offset the negative impact of globalization on the optimal human capital and eventually on the number of educated children in the unskilled families (Eqs. 4.C3 and 4.C5′), but it cannot erase the globalization-induced advantage of skilled families because δG applies to all educated children, whatever their family origin. To remove this advantage, an extra public expenditure for the education of the sole children from unskilled families is then necessary.

Chapter 5

Further Researches and Policy Implications

The preceding four chapters have made an assessment of the economic approaches of the globalization-inequality nexus in advanced economies. We have highlighted that the new wave of globalization which began in the late 1980s/early 1990s is a complex and multidimensional phenomenon which has impacted both the shape of inequality and the feasibility of anti-inequality policies. We have stressed several major mechanisms through which globalization has an impact on inequality in advanced economies: the development of trade with emerging countries, the rise in offshoring and global value chains, the emergence of a global market for talents and the growing mobility of factors and tax bases which generates between-country tax competition. We have found that globalization makes winners, high-skilled and talented workers and capital owners, and losers, low- and middle-skilled workers. We have shown that globalization tends to jeopardize the efficiency of the traditional anti-inequality policies, generating and/or magnifying an inequality-unemployment trade-off, a middle-class curse, a redistribution-progressivity trade-off, a social democracy curse curse and a rise of populism. We have noticed that by favouring the children from skilled families in their access to education and skill attainment, globalization could have reduced intergenerational mobility mobility. This hampers the access to higher education for children from unskilled families and hinders skill upgrading which is the best way to lessen inequality in the longer term. This fifth chapter is devoted to the implications of this diagnosis for further researches and for globalization-consistent anti-inequality policies. In the first section, the general diagnosis on the globalization-inequality nexus and the related major mechanisms are reminded, and their consequences on the research and estimates of the impact of globalization on inequality are highlighted. The second section presents some possible new fields of research on determinants and impacts of globalization which have been until now poorly investigated. The third section tackles the issue of globalization-consistent anti-inequality policies.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4_5

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118

5.1 5.1.1

5

Further Researches and Policy Implications

General Diagnosis and Implications for Researches General Diagnosis

The central diagnosis which emerges from the analyses exposed in the preceding chapters is the following: 1. In advanced economies, trade with emerging countries and offshoring have increased the real income of high-skilled workers and capital owners and lessened the real income of low- and middle-skilled workers, raising thereby income inequality. Nevertheless, globalization could have increased the average income in those economies, provided that the wage adjustment had maintained full employment. In consequence, redistribution from the winners to the losers could have made everyone win and permitted to achieve an optimal situation. 2. But the increasing mobility of factors, of talented managers and performers and of tax bases which are key components of the present wave of globalization has impeded redistribution from the winners to the losers and led to cuts in the taxes paid by the highest incomes, who are also the first winners. Consequently, the growing mobility of factors, firms, talents and tax bases has even magnified the gains of the winners from North-South trade and offshoring. 3. Finally, the globalization-driven rising inequality coupled with the mobility of tax bases fundamentally changes the efficiency and feasibility of social protections, of redistribution, of tax and fiscal policies and of the education structures. The policies are now constrained by a trade-off between inequality and unemployment and a trade-off between redistribution and tax progressivity, entailing an impoverishing of the middle class, a decline of social democracy and an expansion of populism. Schema 5.1 portrays the different links and mechanisms defining the impact of globalization on inequality as analysed in the preceding three chapters. Some factors which are independent from globalization in the short term, such as technological change and skill endowment, are not inserted in the diagram and should obviously be considered when analysing the full determination of inequality. The blue boxes depict the major components of the present wave of globalization. The red boxes depict inequality by distinguishing before-tax and redistribution and after-tax and redistribution inequality. The black boxes present exogenous and intermediate mechanisms and variables which affect the impact of globalization on the two types of inequality and on anti-inequality policies. A blue ‘+’ between X and Y indicates a positive relationship (an in(de)crease in X entails an in(de)crease in Y ), a red ‘-’ a negative relationship (an in(de)crease in X entails a de(in)crease in Y ) and a ‘ ’ a trade-off. As an example, an increase in ‘factor, tax base and firms’ mobility’ (blue box) entails through ‘tax competition’ (black box) a decrease (red ‘-’ relationship) in ‘taxation and redistribution’ or ( trade-off ) in ‘tax progressivity’ (black box) which entails an increase (red ‘-’ relationship) in the ‘post – tax and redistribution inequality’ (red box).

General Diagnosis and Implications for Researches

Schema 5.1 Determinants of the globalization-inequality nexus

5.1 119

120

5.1.2

5

Further Researches and Policy Implications

Implication for Researches on the Globalization-Inequality Relationship

Since the 1990s, a huge number of works have assessed the impact of globalization on inequality. This empirical literature is so vast that it has motivated a succession of review articles.1 If there is now a consensus on the fact that globalization, particularly North-South trade and offshoring, has increased inequality, the extent of this impact is still controversial. In fact, as already noted in Sect. 2.6, the periods, methodologies and indicators of globalization can substantially change from one study to the other, making their comparison difficult. We now utilize the components of globalization and mechanisms highlighted in Schema 5.1 to evaluate the estimations of the impact of globalization on inequality. Estimating the impact of globalization on inequality is typically made from an equation of the type:2 ! ! Ineq = a × glob þ b × other þ c

ð5:1Þ

! where Ineq is an indicator of inequality, glob is a vector depicting the different ! components of globalization, other is a set (vector) of other determinants of inequality, a and b are vectors of coefficients and c is a constant term. Equation (5.1) can be estimated by several methods (OLS, panel, etc.). Several measures of inequality can obviously be utilized. An important distinction must always be made between before-tax and redistribution inequality and aftertax and redistribution inequality because the set of determinants are not the same in both cases. In what follows, the first three subsections are devoted to globalization indicators and the last subsection to other determining variables.

5.1.2.1

Trade and FDI

Let us first consider trade which has been the main globalization indicator selected in empirical works. An important remark is that total trade or total imports (both in per cent of GDP) are inadequate to assess the impact of globalization on inequality. This is because growing inequality is related to North-South trade (NST) and North-South offshoring, particularly in manufacturing, and not to total trade. Consider an advanced country which has known a constant increase in its trade to GDP ratio from 1960 to 2019, this increase being driven by trade with the North until the 1980s and by trade with the South from the 1990s. In addition, this country

1

See the presentation in Chap. 2, Sect. 2.6., and the list in footnote 23. Other methods have been used as the factor content method, decomposition analyses and simulations of computable general equilibrium models (see the presentation in Chusseau et al., 2008).

2

5.1

General Diagnosis and Implications for Researches

121

knows a decrease in inequality in the period 1960–1985 and an increase afterwards. When estimating the impact of globalization on inequality in the period 1960–2019, selecting total trade as an indicator normally reveals a non-significant impact, whereas selecting trade with the South shows a significant positive effect. In consequence, if the purpose is to investigate the impact of the new wave of globalization which began in the early 1990s and is characterized by the development of NST, then selecting total trade as an indicator of globalization is misleading. As revealed by the analyses made in Chap. 2, a clear distinction must be made between North-North trade and North-South trade but also between trade in manufacturing and other types of trade and between offshoring of intermediate goods or tasks and trade of final goods. When those distinctions are made, they typically reveal a significant pro-inequality impact. The reasoning made for trade is obviously applicable to foreign direct investments. FDI to emerging countries normally increases advanced countries’ inequality or/and unemployment, which is not the case for FDI in other advanced economies. Finally, when considering the direct effects of trade and FDI, this typically concerns pre-tax and redistribution inequality. Policy and institutional variables must be added to investigate the determination of after-tax and redistribution inequality.

5.1.2.2

Other Components of Globalization

As depicted in Schema 5.1, trade is not the only component of the new wave of globalization. The importance of the growing mobility of factors, firms and tax bases has been highlighted in Chap. 3. Those factors increase inequality by acting on both extremities of income distribution, i.e. by increasing the income of rich taxpayers and by constraining the funding of redistribution in favour of low incomes. Those additional components refer to cuts in mobility costs, and they act on the after-tax and redistribution inequality through tax and social competition. Consequently, indicators representing the three stages of the mechanism (cuts in mobility costs, tax and social competition, variations in taxation, redistribution and tax progressivity), or even two of them, cannot be concurrently selected as explanatory variables, and one can choose variables depicting one of the three stages in the estimates. If the last-stage variables (indicators of taxation, redistribution and tax progressivity) are selected, additional estimates assessing the impact of the variations in mobility costs on those indicators can be concurrently implemented.

5.1.2.3

Synthetic Indicators of Globalization and Meta-analyses

Globalization is evidently a multidimensional phenomenon. Based on this feature, several works have utilized a synthetic indicator of globalization to estimate its impact on inequality.

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The KOF index is a natural candidate for this purpose because it puts together a large range of variables depicting the different aspects of globalization. The index is calculated for each country, which allows between-country comparisons. In its last version (second revision),3 the general KOF index is composed of two indexes, one de facto and the other de jure. The de facto index is based on observed variables and the de jure on institutional rules. For both, the index is the combination of three components representing economic, social and political globalization. Each of these three sub-indexes is itself the combination of several elements. For example, the de facto index of economic globalization is composed of a set of three trade indexes (trade in goods, trade in services and diversity of trade partners) and another set of five financial indexes (FDI, portfolio investment, international debt, international reserves, international income payments), each set accounting for half of the total economic index. Finally, for each partial index (economic, social and political), one can calculate the equi-weighted combination of the de facto and de jure indexes. Some works utilize the general index, whereas others select one, two or the three of its components taken separately. Some also decompose the economic index between the trade index and the financial index. Most of those works reveal a non-significant or a limited impact of globalization.4 This is not surprising because if the KOF index is indeed a nice indicator of globalization as a whole and if its decomposition usefully portrays its economic, social and political dimensions, those indexes suffer the same limit as total trade regarding their capacity to explain inequality. They put together several elements which have different impacts on inequality, and they disregard the moment when those elements act and the changes in their weights in the calculation of the index. By construction, a general index synthetizing all the dimension of international relations cannot focus on the components defining the new wave of globalization, i.e. North-South trade, offshoring and the growing mobility of factors, firms and tax bases. Figure 5.1 compares the variations in the general KOF index, in total trade (in per cent of GDP), in trade with the South and in offshoring to the South (in per cent of GDP) for the biggest five advanced economies from 1967 up to 2019. It clearly reveals that the two major determinants of the impact of trade on inequality exhibit an upsurge from the early 1990s, displaying significantly different time profile from total trade and the KOF index and that those profiles are in line with the variations in inequality. Finally, given the large number of empirical works, meta-analyses have been implemented to provide a synthetic diagnosis of the impact of globalization on inequality. By construction, those analyses put together works which differ in their indicators of inequality and globalization and in the considered countries and periods of time, even if they can disentangle those differences in more precise presentations.

Gygli et al. (2019) for a presentation of the last version. The first versions are presented in Dreher (2006b) and Dreher et al. (2008). 4 See, for example, Dreher and Gaston (2008) and Potrafke (2015). 3

5.1

General Diagnosis and Implications for Researches

123

Fig. 5.1 Indicators of globalization Sources: KOF Swiss Economic Institute for the KOF index; CEPII, CHELEM database for other indicators. South: Argentina, Bangladesh, Brazil, Brunei, Bulgaria, Cambodia, Chile, China, Colombia, Croatia, Czech Republic, Egypt, Ecuador, Estonia, Hungary, India, Indonesia, Lao PDR, Latvia, Lithuania, Malaysia, Mexico, the Philippines, Poland, Romania, Slovakia, Slovenia, South African Union, Sri Lanka, Thailand, Tunisia, Turkey, Vietnam

The results of meta-analyses must consequently be treated with caution for the reasons already highlighted.

5.1.2.4

Changing Policies and Institutions and Alternatives to Inequality

Chapters 2 and 3 have shown that labour market institutions and public policies have an important role in growing inequality. First, they can modify both before- and after-tax and redistribution inequality. Second, they can substitute alternative changes (e.g. unemployment and labour market withdrawals) to wage adjustment (inequality) to adapt to the globalization-driven decrease in the demand for low- and middle-skilled workers. Third, their changes are to a large extent driven by globalization itself. Hence, limiting the impact of globalization to trade and FDI could underestimate its influence. The mechanisms governing the impacts of public policies and labour market institutions are summarized in Schema 5.2. The sequences portrayed in Schema 5.2 suggest that the simplest way to evaluate those mechanisms is to insert indicators of social policies and labour market

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Further Researches and Policy Implications

Schema 5.2 Institutional determinants and alternatives to inequality *

institutions and imperfections in the equation determining inequality and to concurrently verify (through addition estimations) that (i) the variations in policies and institutions are linked to globalization and (ii) some policies and institutions have opposite impacts on inequality and unemployment of the less skilled (I-U trade-off). A last precaution deserves to be stressed. When inserting indicators of technological change in the estimated relationship, the possible existence of interplays between globalization and technical changes (particularly skilled-biased technical change) must be considered and discussed. Finally, the limits of the use of total trade, total FDI and global indicators to measure globalization and the discussion on the different ways to insert the explanatory variables in estimated models highlight the danger of ‘calculations without theory’.5 The estimates should be based on well-defined economic sequences, and the selected variables must accurately depict the estimated mechanisms.

5.2

New Fields of Research

The possible new fields of research on the globalization-inequality nexus are numerous, and we can evidently not investigate all of them. We shall consequently focus on three topics. First, the development of posted workers could reinforce the

5 Leamer (1994) utilized this expression to characterize the factor content method for measuring the impact of trade on the demand for skilled and unskilled labour.

5.2

New Fields of Research

125

inequality bias of globalization by shortening the amount of non-tradable tasks and services. Second, the COVID pandemic and the Ukraine war have put into light some underestimated risks of global value chains. Third, the concurrent developments of a global market for higher education and a global elite typically change the shape of tertiary education and its interplay with inequality.

5.2.1

Posted Workers

The production of unskilled-intensive non-tradable goods, tasks and services is a key element of the North-South trade and offshoring approaches to rising inequality because they constitute a shelter for the less skilled workers leaving the manufacturing sector. This is particularly important in the case of offshoring in which the possible relocation to the South of unskilled tasks is large (Chap. 2, Sect. 2.2.2 and Appendix D). By tempering the decline in unskilled labour demand, the sector of non-tradables lessens the rise in both inequality and unemployment. Hence, the vanishing of this sector could considerably amplify the losses of unskilled and middle-skilled workers. This is what could result from the expansion of posted working. Posted working consists in a temporary displacement of workers from one country to another for specific tasks (services), the labour cost and working conditions keeping at least partially those of the workers’ country of origin. Then, the worker has a cost which is between that of her/his country of origin and that of the receiving country. When the difference in labour cost between the two countries is sufficiently large, firms in the host country are incited to subcontract the tasks to foreign firms which send posted workers. Posted working typically concerns sectors as construction and civil engineering, catering, tourism, agriculture and even manufacturing. The analysis of posting typically applies to European Union countries where the Directive 91/71/EC, amended in 2018 by the Directive 2018/757/EU, organizes the posting of workers inside the EU. The first directive authorized inside-EU posting provided that the minimum wage and certain minimal working conditions of the host country were respected. The second directive extends those minimal conditions, particularly for longer-term contracts. The within-EU posting rules set that the social security contributions are those of the country of origin. This typically makes posting very profitable in countries where, as in France, those contributions represent a large part of the labour cost. The impact of posting work on the French labour market has recently been studied and analysed by Muñoz (2022a, b). She points out several characteristics of posted workers: 1. They are poorly paid, often significantly less than French workers with the same type of job, and a large number of them are paid at the French minimum wage. 2. A non negligible part of them are French residents posted in France by foreign companies (e.g. located in Luxembourg). This permits to French firms to utilize services by French workers without paying the French social security contribution.

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3. In France, posted workers represent 2.2% of total employment in agriculture, 1.7% in construction and 0.8% in manufacturing, essentially in low-skilled tasks. Three mechanisms contribute to lessen the cost of posted workers compared to resident workers and incite thereby firm to utilize posting: 1. The possibility to pay low social contributions. 2. The social contributions themselves can be calculated on a basis which is not the wage paid to the posted worker in the host country. 3. The difference in reservation wages between the country of origin and the receiving country makes that the same job/skill can be significantly less paid when employing a posted worker rather than a national one. Finally, it is clear that posting is different from immigration because all the labour market rules of the host country apply to an immigrant. Hence, posting should rather be analysed as an import of services or an offshoring of tasks, the extra cost due to the enforcement of certain labour market rules of the host country being treated as custom tariffs or offshoring costs. If posting tends to grow in Europe and if this practice expands to other areas, the inequality bias of globalization could be reinforced, and this should be inserted in models and estimates of the globalization-inequality relationship.

5.2.2

Global Value Chains and Increasing Economic Risks

Throughout this volume, we have limited our observations and analyses to the developments which occurred before 2019, i.e. before the COVID pandemic and the Ukraine war. These two shocks have typically changed our appreciation of the benefits of globalization and particularly of global value chains. They show that global value chains can be risky when some stages in the production processes are located in a limited number of countries or when one country concentrates a large share of one or several components necessary for the production of key commodities. If those countries stop providing key components, then the production chain is broken or sharply reduced, entailing breaks in the provision of goods and/or large increases in their prices. This can in turn entail deficits and corporate failures, forcing governments to sustain and subsidize firms. This is exactly what occurred during both the COVID pandemic and the Ukraine war. Those questions open several lines of research. First, why have the risks linked to global value chains been underestimated, and will they now be considered in the firms’ strategies? Are those risks insurable and how will they be treated if not? What are the impacts of such changes on inequality? At the first glance, one could diagnose that they should reduce inequality because they encourage a relocation to the North of productions and tasks which had been offshored to the South and because most of those tasks are low and middle skill-intensive. But in fact the outcome could considerably differ depending on the country and the sector.

5.2

New Fields of Research

127

As an example, suppose that the active ingredients of several medicines are relocated from China to Europe. This could increase the demand for low- and middle-skilled workers in Europe. But pharmaceutical companies could prefer to utilize robots for their production, which can in turn increase the demand for skilled workers because of capital-skill complementarity. Alternatively, the companies could relocate their production to Central Europe where wages are relatively low, which has no impact on the demand for labour in advanced European countries. In all cases, the prices of medicines would increase, which could jeopardize the health and purchasing power of low paid and poor households. The outcome in terms of inequality then depends on the relative cost of each option, on the substitutability/ complementarity between factors, on the health institutions, etc. Finally, the very shape of globalization could be substantially modified if the political division between democracies and autocracies turn out into an economic division of the world. The between area rules of trade and the global value chains could then be critically modified. New researches and models of international relationships and of their effects on labour markets and inequality should then be implemented.

5.2.3

Education and the Emergence of a Globalized Elite

Over the last 35 years, the development of a globalized economy has come with the development of a globalized elite at the world level. Top managers and top executives of multinational firms and banks, international civil servants, highly talented performers, researchers and experts, etc. are now forming a global elite which shares common characteristics: the fluent use of English as lingua franca, frequent travels around the world, similar way of life and similar cultural tastes. Those elites attend the same international hotels, the same international conferences, the same cultural exhibitions and, more and more, the same universities. In this respect, the passage in a prestigious American or Anglo-Saxon university (and some other) is often a condition to accede to the global elite. In those establishments, the selection is severe and the registration costs are high. A number of theoretical and empirical works have shown that both more selective admission rules (even when following purely meritocratic standards) and high fees tend to lessen intergenerational mobility and to foster social reproduction.6 An important question is whether the emergence of global universities could lead to the emergence of a self-reproducing globalized elite without national linkages. 6

Bergh and Fink (2009), Brezis (2010), Chusseau and Hellier (2011) and Brezis and Hellier (2018) develop theoretical approaches of the impact of selective admission rules, and Hanushek and Woessmann (2006), Marks et al. (2006), Pfeffer (2008) and Dronkers et al. (2011) present empirical works on this subject. The impacts of high fees, education cost and public subsidies are analysed by, for example, Caucutt and Kumar (2003), Akyol and Athreya (2005) and Gilboa and Justman (2009).

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This could typically weaken national policies, disconnect economic elites from the countries’ population and widen the gap between the populations and the deciders and finally increase inequality by the top. Hence, the analysis of the emergence and intergenerational reproduction of a globalized elite and of its impact on inequality and intergenerational mobility is a key issue which deserves further researches.

5.3

Globalization-Consistent Public Policies

Globalization noticeably modifies the efficiency of public policies. This impact has been analysed in Chap. 4 for anti-inequality policies. But this change concerns a large range of policies and has been studied for a long time as regards Keynesian short-term policies. As a matter of fact, openness reduces the efficiency of demandsided policies because part of the rise in demand goes to imported goods and services. As before, we shall nevertheless focus on tax and redistribution policies which have a direct impact on inequality. We firstly underline that a number of public services which are freely provided to all citizens could be removed for those paying their taxes abroad, which would raise the cost of tax base outflows. We subsequently discuss ways to bypass the leaving of mobile tax bases.

5.3.1

Conditional Provision of Public Services and Social Advantages

In several advanced countries, a number of public services funded by taxes and social contributions are provided to nationals or even residents regardless of the country where they pay their taxes. For instance, French children with parents working and paying their taxes in the UK can freely attend the French education system, and French families paying their taxes and social contributions abroad have a free access to the French public health system. Another example is that of the access to roads for road transport companies. The upsurge in offshoring and the development of online shopping have multiplied between-country intermediate good and commodity transportations, a large share of which are made by road. This generates important extra costs and extra taxes for the maintenance of the road network as well as the building of new roads to go around cities and populated areas. If social competition favours transport companies located in countries with low social protection, the related additional costs are not accounted for in their transport prices. This jeopardizes market efficiency because prices no longer embody the effective transport costs. This also fosters the firms located in countries with low wages and low social protection because it reduces the cost of larger distance.7

7

Within the EU, for instance, it can be profitable to contract with Polish transport companies for deliveries inside Germany or inside France despite a much larger distance made by Polish trucks.

5.3

Globalization-Consistent Public Policies

129

The above remarks open a range of researches on the possibility and conditions of discrimination in the access to certain public services and public equipment between those who pay taxes in the country (and hence pay for the provision of the services) and those who do not. The ways to make the latter pay for those services without departing from existing rules and the way and possibility of changing certain rules are key issues to investigate. Finally, those issues are constituents of a larger research programme which consists in studying and determining policies which increase the mobility cost of tax bases and taxpayers.

5.3.2

Globalization-Consistent Taxation

To prevent tax base outflows, the domestic levies cannot exceed the sum of foreign taxes and mobility costs (see Sect. 3.1.1). This typically entails tax competition (Sect. 3.1.2) and under-taxation of capital, profits and high incomes (Sect. 3.2). There are two ways to escape from those unwilling outcomes. The first way consists in international agreements on minimum tax rates. This solution is nevertheless subject to several limits. It firstly usually requires unanimity which is difficult to reach because some countries, particularly small ones (see Sect. 3.1.2), benefit from tax competition. Hence, (i) the minimum rate could be rather limited so as to be accepted by all countries, and (ii) there must be credible menaces inciting the reluctant countries to sign the agreement. The second limit is that the agreement is typically not an equilibrium, which means that countries are ex post incited not to fulfil the commitment. Sanctions should thus be applied to offenders. The OECD agreement on a 15% global minimum corporate tax rate of multinational firms which should come in from 2023 is an example of this type of measure.8 This agreement has been signed in 2021 by 137 countries, all advanced economies being concerned. The agreement was postponed because of the opposition of Ireland, Hungary and Estonia, three small countries which had a rate below 15%, and their agreement has been reached under the condition that the 15% rate will not be raised. A few developing countries still refuse to sign. It must be noticed that the 15% rate is very low compared to the rates applied in most countries before the mid-1980s, i.e. before the beginning of the ‘race to the bottom’ dynamics. It is also well below the average rate in advanced economies which was 23.5% at the moment of the signature. The second way to escape from tax avoidance is to change the definition and calculation of the bases so as to make them become non-mobile.9 The bases must then be attached to a quantity which is not mobile. This is in particular possible for corporate taxation.

8

See OECD (2021b). This can be difficult for resident-based taxation because the rich tax payer can always migrate to low-tax countries.

9

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5

Further Researches and Policy Implications

The replacement of source-based corporate taxation by destination-based corporate taxation in which the tax is based on the location of buyers instead of the location of profits provides a tool to avoid tax competition and the related race to the bottom. A large literature has proposed and studied a destination-based cash-flow taxation (DBCFT).10 This taxation schedule combines two elements, i.e. cash-flow taxation and destination-based taxation. Since cash-flow taxation responds to problems which are not directly linked to globalization, we shall focus here on the destination-based taxation of profits. We know that source-based corporate profit taxation can be avoided in several ways: relocation to low-tax countries of production, of benefits (through intra-MNF price setting entailing profit-shifting) and of intellectual property, financing of affiliates by loans granted by other affiliates, changes in the composition of the compensation for executives and high-paid employees; etc. Suppose that instead of being source-based, the benefits are accounted for in the country where the sales are realized and based on the firms’ sales. The tax is ‘destination-based’ because it is based on the sales realized in the country of destination of goods and services. Then, the tax base encompasses imports and not exports in its calculation. By basing the tax on the location of demanders instead of the location where profits are declared, a destination-based tax cannot be avoided through base mobility because then the firm should give up on selling in the country. To simply synthetize the rationale and major features of a destination-based taxation of profits, consider a country setting a tax rate on firms’ profit based on their total sales in the country. To calculate this tax base, the government multiplies the total profit of the firm at the world level by the share of the country in the world total sales of the firm. This share encompasses the production in the country sold in the country and the production abroad sold in (i.e. imported by) the country. In contrast, it does not include the production in the country sold abroad (exports): Tax base = Profit of the firm at the World level ×

Sales of the firm in the country Sales of the firm at the World level

With: Sales of the firm in the country = Production of the firm in the country - Exports of the firm to other countries þImport of goods produced by the firm in other countries

10

See, for example, Shome and Schutte (1993), Devereux and de la Feria (2014), Auerbach (2017), Hebous et al. (2019) and Auerbach et al. (2021).

5.3

Globalization-Consistent Public Policies

131

This taxation schedule exhibits the following features: 1. The usual forms of profit-shifting and tax avoidance (relocation of production, displacement of profits to affiliates in low-tax countries, etc.) are now ineffective since they have no impact on the so-computed tax base. 2. If other countries set the same type of taxation, then each country can decide for its tax rate independently from others, and there is no tax competition and no race to the bottom. 3. If other countries maintain a source-based tax on profit, then firms are incited to relocate their production in the country with the destination-based tax because producing in this country entails a zero rate on the source-based profits. 4. Finally, when other countries maintain source-based profit taxations, the country which sets a destination-based taxation typically knows a reduction in inequality if capital and high-skilled workers are internationally highly mobile and low- and middle-skilled workers are not mobile. This is because the relocation of production in the country comes with an increase in its capital and high skill endowments (due to international mobility), but not in its low- and middle-skilled labour endowment. This shift in the country’s relative endowments typically increases low- and middle-skilled wages and decreases high-skilled wages and return to capital, reducing thereby inequality. Note that if the country is sufficiently large, this also raises inequality in other countries with source-based profit taxation because of the shift in their factor endowments. The above discussion shows that the implementation of a destination-based tax on profits not only permits to erase tax competition but is also beneficial by encouraging firms to produce in the country which adopts this taxation structure and by reducing inequality. However, this implementation can generate new difficulties. First, if all countries do not set this type of taxation, its adoption can contravene between-country anti-double tax treaties as the convention settled between EU countries. This problem can be easily solved by deducting from the calculated tax the share corresponding to levies already paid in other countries.11 More broadly, the compliance of destination-based profit taxation with international or regional rules and treaties (e.g. World Trade Organization rules and EU rules) is a key issue and deserves further researches. Finally, if this type of taxation can be enforced in the case of final goods, its avoidance could be easier for firms selling intermediate goods. In this case, firms could sale the intermediate goods in countries where the tax does not exist or has a low rate (which reintroduces tax competition), their relocation to the production sites in other countries being subsequently made by the buyer through intra-firm transfers. All in all, the analysis of taxation schemes permitting to counter tax avoidance and tax competition is still an open field of research. For instance, if the rate on the tax base (world profits of the firm× share of the country in the firm’s sales) is 35% and if half of the sales in the country is imported from another country with a sourcebased taxation at a 15% rate, then half of the tax base should be taxed at 20% (35–15%), the remaining half (representing sales of goods produced in the country) being taxed at 35% rate.

11

Conclusion

If I had written this book a few years ago, I would have certainly concluded that globalization is an irreversible process and that the main challenge as regards inequality is to invent new tools and policies permitting to reverse its upward trend within an increasingly globalized world. However, in the last years, the general diagnosis on globalization has changed for three major reasons. First, the COVID pandemic and the Ukraine war have put into light some risks and deficiencies of the globalized economy which had been to a large extent underestimated. The concentration of large segments of production in a limited number of countries, with one of them gathering a critical share of production stages, has proved to generate a potential threat on the world economy. Inserting the related risks in the firms’ decisions could moderate, or even partially reverse, the development of global value chains which has been a major engine of globalization in the last three decades. Those risks are also well-diagnosed by governments in advanced countries, and public authorities are setting a series of measures to incite multinational firms to ‘in-shore’ the production of key components. Second, the rising opposition between democracies and autocracies, the development of the latter having been to a large extent nurtured by technological transfers from the former, generates new challenges for the shape of globalization and its impact on inequality. In particular, the growing antagonism between China and the USA for the leadership in the world economy and in the world order, coupled with the new risks generated by the new Chinese policy, could lead to a displacement out of China of a number of productions in the global value chains. This reorganization of value chains is costly and could significantly modify the geographic distribution of productions at the world level. Third, the lowering of the carbon intensity of economies linked to the climate challenge could increase the freight cost for commodities, entail a reduction of distances in the value chains and substantially modify the production processes as well as the consumption patterns. © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4

133

134

Conclusion

The above three elements could induce a large reorganization of the global value chains and of their geographical distribution. In fact, the future of the globalization – inequality relationship in advanced countries, as well as of the anti-inequality public policies, typically depends on the forthcoming shape of the global economy. If, following the COVID pandemic and the Ukraine war, the frictions between the USA and China tend to diminish and globalization goes back to ‘business as usual’, its impact on inequality will depend on several developments: 1. There could be a move in productions and in offshoring in favours of new countries due to the increase in production costs in China. 2. The growing robotization of production processes could provide an alternative to offshoring and make production stages be relocated in advanced countries. This does not compulsorily increase the demand for and the pay of low- and middleskilled workers, particularly if robots and skill are complements in production. In addition, robotization could also replace unskilled workers in non-tradable tasks, reinforcing thereby inequality. 3. The climate challenge will anyway remain a crucial issue, and the related changes in the energy mix, in technological choices and in the consumption patterns will indubitably induce non-negligible modifications in both the globalization process and inequality. In contrast, if the opposition between China and the USA remains durable and entails a large geographical reallocation of tasks in the global value chains, some new challenges will emerge and will modify the shape of globalization. In-shoring a number of tasks in advanced countries could increase their demand for low- and middle-skilled workers. But other outcomes are possible, like the robotization of in-shored tasks or move from risky countries to secure European emerging countries. The impact of the changes in globalization and robotization upon inequality will also depend on their speed. Smooth adjustments are typically less costly and permit to modify production processes without major disruptions. In contrast, if the relocation of production stages, the robotization of production processes and the adjustment to the climate change are rapidly implemented, which could be necessary, this could come with bottlenecks and growing inflation due to shortages in primary goods and components. The rise in prices and the move towards new and expensive goods are typically detrimental to the modest and poor families. Finally, robotization and the changes in production processes could modify the shape of globalization. The countries specialized in the sector of robots, in the industries participating in the current energy shifts as well as in the main components necessary for their production will have a central position in the forthcoming configuration of globalization. In any case, on top of the new challenges already highlighted, several characteristics of the present wave of globalization will remain significant in the forthcoming years. In particular, the mobility of tax bases and firms will persist as well as its impact

Conclusion

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on the taxation of the highest incomes and fortunes and on social dumping and social competition. The need for new taxation schedules, new ways of organizing redistribution and new international agreements on minimum taxes, on minimum social rights and on the fight against tax evasion is still on the agenda (Grimalda et al., 2020). The creation and development of new policies could be the only way to escape from ‘Rodrik’s trilemma’ (the impossible concomitance of globalization, national sovereignty and democracy; see Rodrik, 2011).

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Author Index

A Abraham, F., 98 Acemoglu, D., 53–56 Adler, M., 58 Akcigit, U., 83 Akyol, A., 127 Allingham, M.G., 84 Alstadsaeter, A., 85 Altshuler, R., 79 Athreya, K., 127 Auer, R.A., 103 Auerbach, A.J., 130 Autor, D.H., 10, 11, 47, 54–57, 101 Azzimonti, M., 102

B Baldwin, R.E., 48, 79 Barone, G., 101 Barrios, S., 79 Bartelsman, E.J., 77 Becker, J., 57, 80 Beetsma, R., 77 Beissinger, T., 46 Bénassy-Quéré, A., 78, 79 Benedetto, G., 101 Bergh, A., 127 Bierbrauer, F., 82 Bikakova, A., 92, 93 Blanchard, E., 57 Blank, R.M., 92 Blundell, R., 81 Böckerman, P., 55

Borghans, L., 58 Borissov, K., 103 Borsook, I., 103 Bottini, N., 60 Bound, J., 59 Bourguignon, F., 58, 59 Brezis, E.S., 127 Broccolini, C., 60 Bucovetsky, S., 78, 82

C Cartiglia, F., 104 Caselli, M., 98, 101 Caucutt, E., 127 Cavenaile, L., 57, 60 Chang, R., 102 Chung, K.H., 58 Chusseau, N., 45, 59, 93, 120, 127 Colantone, I., 101 Cox, R.A.K., 58

D Davis, D.R., 40–42, 50, 66, 71, 93 De La Feria, R., 130 De Mooij, R., 79 Desjonqueres, T., 59 Devereux, M.P., 78, 79, 130 Dhillon, A., 78 Dhumale, R., 59 Dinopoulos, E., 103 Dippel, C., 101

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4

147

148

Author Index

Docquier, F., 101 Dreher, A., 79, 122 Dronkers, J., 127 Duffy, J., 52 Dumont, M., 59, 92–94, 98 Durlauf, S., 105

Heimberger, P., 59, 80 Hellier, J., 32, 33, 36, 38, 45, 57, 59, 83, 93, 99, 100, 103, 127 Helpman, E., 59, 103 Hindricks, J., 81 Hines, J.R., 79

E Ederveen, S., 79 Egger, H., 43 Eicher, T.S., 104 Elsby, M., 47

J Janeba, E., 103 Jestl, S., 13 Johannesen, N., 83 Johnson, G., 59 Justman, M., 127

F Falvey, R., 10, 103 Feld, L.P., 79, 83 Feng, A., 55 Findlay, R., 103 Fink, G., 127 Foster-McGregor, N., 57 Freeman, R.B., 59 Frenkel, J.A., 78 Frydman, C., 58 Fuest, C., 79

G Gabaix, X., 58 Gaston, N., 122 Gersbach, H., 58 Gilboa, Y., 127 Goldin, C., 54 Goos, M., 10, 55–57 Graetz, G., 55 Gravina, A.F., 57 Greenaway, D., 53 Griliches, Z., 52 Grimalda, G., 135 Groot, L., 58 Grossman, G., 48, 51, 103 Guyton, J., 85 Gygli, S., 122

H Hamermesh, D.S., 52 Hanushek, E.A., 127 Harrigan, J., 10, 57 Haskel, J., 58, 94, 98 Hebous, S., 130 Heckemeyer, J., 79

K Kanbur, R., 78 Karabarbounis, L., 47 Katz, L.F., 54, 55 Keen, M., 78 Keller, W., 56, 57 Kemeny, T., 60 Kerr, S.P., 57 Kierzkowski, H., 103 Kind, H.J., 79 Kleven, H., 81, 83, 84 Kreikemeier, U., 43 Kreuter, H., 101 Krugman, P., 38, 39, 59, 79, 92, 93 Krusell, P., 52 Kumar, K., 127 Kurokawa, Y., 59

L Landier, A., 58, 82 Leamer, E.E., 124 Lehmann, E., 82 Lewandowski, P., 56, 57 Lindquist, M.J., 53 Ludema, R.D., 79

M MacDonald, G.M., 58 Maffini, G., 79 Malgouyres, C., 101 Mankiw, N.G., 48, 80 Manning, A., 10, 57 Manyika, J., 58 Marks, G., 127 Martin, C., 98

Author Index Meinhard, S., 91 Melitz, M.J., 43, 47 Mendoza, E.G., 79 Michaels, G., 55 Mierzkowski, P., 77 Milner, H.V., 101 Mirrlees, J.A., 80, 81 Moreno, L., 98 Muñoz, M., 125 Murphy, K., 58

N Neiman, B., 47

O Oldenski, L., 10, 56, 57 Oslington, P., 41 Overesch, M., 78

P Paty, S., 79 Persson, T., 79 Pfeffer, P.T., 127 Plantin, G., 82 Potrafke, N., 91, 122

R Ranjan, P., 104 Ravallion, M., 59 Rayp, G., 94 Razin, A., 78 Reulier, E., 83 Riedel, N., 80 Rigby, D., 60 Rincke, J., 78, 84 Rodriguez, D., 98 Rodrik, D., 135 Rosen, S., 58 Rossi-Hansberg, E., 48, 51 Rubinstein, A., 97

S Sadka, E., 78

149 Saez, E., 81 Sandmo, A., 84 Schaltegger, C.A., 83 Schmutzler, A., 58 Segerstrom, P., 103 Shapiro, C., 43 Simula, L., 82 Singh, A., 59 Slaughter, M.J., 59 Slemrod, J., 79, 84 Solow, R., 43 Stanig, P., 101 Stiglitz, J., 43 Subramanian, A., 58 Swagel, P., 48

T Tabellini, G., 79 Takahashi, T., 14 Tesar, L.L., 79 Thoenig, M., 53 Tobias, A., 83 Trannoy, A., 82, 99 Traxler, C., 84

U Utar, H., 56, 57

V Verdier, T., 53

W Wildasin, D.E., 77, 81 Willmann, G., 57 Wilson, J.D., 77, 78 Winchester, N., 53 Woessmann, L., 127 Wood, A., 53 Wooton, I., 79

Z Zabojnik, J., 58 Zodrow, G.R., 77, 78

Subject Index

A Agglomeration effect, 79

Foreign direct investment (FDI), 1–11, 27, 78, 79

B Bargaining, 7, 38, 39, 93, 94, 96–99, 108–112

G Global value chains, v, 29, 33, 48–52, 133, 134

C Capital mobility, 11, 30, 47–48, 77–80 Capital-skill complementarity (CSC), 52–53, 127 Comparative advantage, 21, 30–48 Compensation effect, 79, 91, 99, 106 Corporate tax (and taxation), vi, 13, 14, 27, 74, 76–80 Cost of education effect, 104, 105, 116

H Heckscher-Ohlin-Samuelson (HOS), 30, 32, 33, 37, 40, 42, 44, 49, 58, 91, 103

D Destination-based taxation, vi, 130, 131 Diversification cone, 32, 34–37, 40, 45, 64

E Education, vi, 20–23, 46, 54–57, 91, 100, 102–107, 113–116 Efficient bargaining, 94, 96–99

F Fair wage, 43, 65

I Immigration, 12, 13 Incentive effect, 103–105, 107, 116 Income tax (and taxation), 13–15, 27, 74, 76, 77, 80–83, 100 Inequality-unemployment trade-off (IUT), 92, 93 Intergenerational mobility, vi, 105, 107, 117, 127, 128 Intermediate goods, v, 2, 5, 27, 48–50, 54, 60, 67

L Labour market, vii, 1, 24–26, 28, 33, 35, 38–40, 42, 43, 45–47, 50, 54, 56, 60, 62, 64, 65, 69, 71, 87, 92, 93 Labour market failures, 38–44 Labour market rigidity(ies), 18–26

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Hellier, Globalization and Inequality in Advanced Economies, Economic Studies in Inequality, Social Exclusion and Well-Being, https://doi.org/10.1007/978-3-031-31256-4

151

152 M Middle class, vi, vii, 8–10, 57, 87, 99, 100, 102, 106, 107 Middle class curse, vii, 91, 99–102, 106 Minimum wage, vi, 24, 25, 28, 38–42, 55, 91–94 Mobility cost, vi, vii, 11–12, 27, 73–77, 86, 87, 99 Mobility of tax bases, 1, 11–15, 61, 73–77, 86–89, 91, 118, 134

N North-South HOS model, 30, 32, 49, 92 North-South Trade (NST), vi, vii, 29–48, 52, 54–56, 59–61, 73, 86, 87, 100, 102–104, 114, 120

O Offshoring, v–vii, 1–11, 29, 47–53, 56, 57, 60, 61, 67–69, 73, 93, 96, 100, 102, 134 Offshoring in tasks, vii, 50, 91, 92

P Polarization, vii, 10, 29, 54–57 Populism, vi, vii, 91, 100–102, 107 Posted workers, 124–126 Productivity, 25, 33, 37–38, 43, 49–52, 54, 58, 60, 69, 82, 95, 96, 98 Progressivity, vi, vii, 11–16, 82, 100, 106 Progressivity-redistribution trade-off, 91, 99–102, 106 Property rights, 53–54 Public debt, 16–18, 28, 91, 102

R Race to the bottom, 73–77, 83, 86–89, 99 Redistribution, vi, vii, 1, 7, 8, 10, 16, 17, 27, 28, 60, 61, 73, 80–82, 86, 91, 92, 99, 100, 102, 106, 107, 135

Subject Index S Skill biased technological change (SBTC), 41, 42, 52–54, 69 Skill endowment, 18–26, 30, 31, 34–36, 38, 39, 44–47, 71, 93, 103, 107 Skill premium, 30–36, 39–41, 43–46, 49, 50, 52–54, 62–67, 69, 71, 103, 106, 107 Social democracy curse, 91, 100–102, 117 Source-based taxation, 76, 88–89, 131 Stages of globalization, 33–37 Superstars, vii, 29, 58–60

T Task biased technological change, 55 Tasks, v, vii, 2, 5, 29, 48–53, 55–57, 60, 68, 69, 71, 93, 134 Tax base, v–vii, 73–75, 79, 80, 83–89, 99, 100 Tax base mobility, vi, 73–89 Tax competition, vi, vii, 73–89, 91, 99, 100, 102, 106 Tax evasion, 74, 83–89, 135 Technology, 5, 29, 30, 32, 33, 37–38, 44, 50, 52–55, 57, 60, 61, 66–70, 82, 85, 86, 95, 97, 103

U Unemployment, vi, vii, 1, 16, 18–26, 28, 33, 34, 38–47, 50, 56, 60, 64–67, 71, 92–97, 99, 100, 102 Unionization, 24, 25, 55, 94–99 Union monopoly, 94, 95

V Value chains, 27, 133, 134