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Globalization, Growth, Inequality, and Social Safety Nets in APEC Economies KYE WOO LEE and CHANYONG PARK

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Globalization, Growth, Inequality, and Social Safety Nets in APEC Economies KYE WOO LEE and CHANYONG PARK Globalization, Growth, Inequality, and Social Safety Nets in APEC Economies KYE WOO LEE AND CHANYONG PARK This paper examines the forward linkage between trade liberalization and economic growth, economic growth and income inequality, and income inequality and economic growth, and inequality and social safety nets. It then suggests the directions for strengthening the social safety net in APEC member economies. The paper reviews major studies in recent years and concludes that in many countries trade openness is associated with more rapid growth, and economic growth with increased inequality. In addition, it shows that inequality is harmful for growth, and social safety nets are necessary for dealing with negative effects of growth engendered by trade and investment openness. I. APEC’S AGENDA: ECONOMIC OPENNESS AND GROWTH The Asia-Pacific Economic Cooperation (APEC) is an organization that pursues member economies’ growth and economic prosperity through economic integration. All advanced member economies agreed to liberalize trade by 2010, and developing economies by 2020. These give rise to two questions: How is economic integration linked to economic growth and prosperity, and, why and how are the social safety nets related to economic integration and growth? These are the main topics in this paper. Using a review of empirical studies to date, this paper will, first, show that there is a forward linkage between trade liberalization and growth, between growth and inequality, between inequality and growth, between inequality and social safety nets, and between social safety nets and growth. APEC’s agenda of globalization or economic openness promotes economic growth, but it sometimes results in worsening inequality, which is proven to be harmful for economic growth. This economic linkage, in addition to social and political reasons, justi- fies why social safety nets should be strengthened in those economies pursuing economic openness. Second, the paper will suggest the directions for strengthen- ing social safety nets in APEC member economies. Kye Woo Lee is a Professor at the Graduate School of International Studies; Director, Institute for Interna- tional Trade and Cooperation, Ewha Womans University; and Advisor of Head Institution, APEC Social Safety Net Capacity Building Network, Seoul. Chanyong Park is Director, Korea Institute for Health and Social Affairs (KIHASA), and Director of Head Institution, APEC Social Safety Net Capacity Building Network (SSNCBN). Asian Development Review, vol. 19, no. 2, pp. 47-66 © 2002 Asian Development Bank 48 ASIAN DEVELOPMENT REVIEW The growing integration of economies and societies around the world (i.e., globalization), by means of trade, foreign investment, and migration, is a complex process, and its effects remain highly controversial. Ever since Ricardo advanced his theory of comparative advantage and the division of labor in the late 1800s, much has been said of free trade helping achieve greater efficiency, an important factor contributing to economic growth (Solow 1956). However, this is a onetime gain in allocative efficiency. In the long run, the question is whether free trade would promote higher growth rates. Conceptually, trade liberalization can affect an economy’s growth rate by creating incentives for greater domestic investment. In addition, trade reform could encourage foreign direct investment (FDI), with attendant spillovers of advanced technologies and new business practices that increase overall produc- tivity and growth in domestic firms (Bannister and Thugge, 2001). There have been a number of attempts to relate trade policy variables to growth rates empirically (Frankel and Romer 1999, Sachs and Warner 1995, Dol- lar 1992, Edwards 1992). These studies find that trade openness is positively associated with more rapid growth. Nevertheless, a recent study by Rodriguez and Rodrik (2000) points out that there is no clear-cut relationship between trade liberalization and growth and that the previous studies have not adequately controlled for the influences of other policies on growth. In particular, the effects of trade reform on growth de- pend on the existence of other complementary macroeconomic and structural policies and the creation of appropriate institutions, such as privatization, ex- change rate reform, private property rights, fiscal stabilization, rule of law, etc. In other words, undertaking trade reform without implementing appropriate macro- economic and exchange rate policies to improve competitiveness will be less effective in promoting growth. The experience of the World Bank also confirms the positive relationship between trade and growth, and the findings of Rodriguez and Rodrik. During the period 1980-1993, the World Bank helped member countries implement macro- economic stabilization and structural adjustment reforms. About 25 percent of the total number of conditions related to macroeconomic stabilization policies, and 40 percent consisted of measures to improve market-oriented economic develop- ment (trade liberalization, public enterprise reform, and privatization). The remaining 35 percent of the conditions were related to sector reform, with a focus on financial and agricultural sector reforms. Of the adjustors sampled by the World Bank, about two thirds implemented the suggested integrated policies, thereby reducing inflation, improving the resource balance, and stabilizing for- eign exchange reserves. These adjustors also posted improved growth rates in the post-adjustment period (Jayarajah et al. 1996). However, a more recent study finds a definitively positive relationship between international trade and growth even after taking into account the effects GLOBALIZATION, GROWTH, INEQUALITY, AND SOCIAL SAFETY NETS IN APEC ECONOMIES 49 of other complementary policies and measures mentioned by Rodriguez and Rodrik. A study by Dollar and Kraay (2002) using a panel data of 100 countries and four decades confirms that integrated economies tend to grow faster. Per cap- ita income growth of the top third developing countries in terms of the increases in the ratio of trade to gross domestic product (GDP) was accelerating in the last three decades, catching up to the rich countries and leaving other developing countries much further behind. They also find strong positive effect of trade on growth even after controlling for changes in other economic policies and vari- ables mentioned by Rodriguez and Rodrik (2000). The top one third also experienced a large increase in trade: from 16 percent of GDP to 33 percent, compared to an increase from 37 to 50 percent for the rich countries. The remaining two thirds of developing countries have actually experienced a decline in the trade to GDP ratio over the same period. The developing globalizers ex- perienced an increase in their growth rates from 2.9 percent per year in the 1970s to 3.5 percent in the 1980s, and 5.0 percent in the 1990s, while rich country growth rates slowed down over this period from 3.1 to 2.2 percent. The average growth rate of the developing nonglobalizers declined from 3.3 percent per year in the 1970s to 0.8 percent in the 1980s, recovering to only 1.4 percent in the 1990s. The new globalizers among developing countries include People’s Repub- lic of China (PRC), Malaysia, and Thailand in East Asia; Bangladesh and India in South Asia; and several Latin American economies such as Argentina, Brazil, and Mexico. II. ECONOMIC GROWTH AND INEQUALITY Economic integration opens up opportunities for the old and new globaliz- ers, but it also creates tensions and risks, both between countries and within each of them. Between countries, globalization is now mostly reducing inequality. Among some 5 billion total developing country populations, about 3 billion people live in “newly globalizing developing countries.” During the 1990s this group grew at 5 percent per capita, compared to 2 percent for the rich countries. The average income gap between the new globalizers and the rich countries has narrowed. The number of extreme poor living on less than $1 per day in the new globalizers has declined by 120 million between 1993 and 1998 (The World Bank, 2002). However, the gap between the rich and the new developing globalizers on the one hand and the developing nonglobalizers on the other has widened. Many poor countries with about 2 billion people have been left out of the process of globalization. Many of them are becoming marginalized in the world economy, often experiencing declining incomes and rising poverty. The least developed countries account for less than 0.5 percent of the world’s exports and receive less than 1 percent of the world’s total FDI. 50 ASIAN DEVELOPMENT REVIEW Within countries, some analysts argue, globalization has not affected ine- quality (World Bank 2002, Fraser Institute 2002). For example, the Economic Freedom of the World Report 2002 concludes that: first, economic freedom (and therefore globalization) led to greater wealth creation than under more restrictive systems; and second, globalization did not produce marked income inequality. The Freedom Report does confirm that economic freedom and growth are positively correlated. The most liberal economies enjoyed higher average annual growth rates (2.5 percent) than the least liberal ones (-1 percent per year) during the 1990s (see the right scale of Figure 1). However, the conclusion on income inequality is misleading. In examining the effects of globalization, the report shows only a static situation for income
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