A quarterly magazine of the IMF

December 2001, Volume 38, Number 4

The Rising Inequality of World Income Distribution

Robert Hunter Wade
Does it matter what is happening to world income distribution (among all 6.2 billion
people, regardless of where they live)? Amartya Sen, the recent Nobel laureate in
economics, warns that arguing about the trend deflects attention from the central
issue, which is the sheer magnitude of inequality and poverty on a world scale.
Regardless of the trend, the magnitude is unacceptable (Sen, 2001). He is right, up to
a point. The concentration of world income in the wealthiest quintile (fifth) of the
world's population is indeed shocking and cannot meet any plausible test of
legitimacy. The chart shows the distribution of world income by population quintiles.
Ironically, it resembles a champagne glass, with a wide, shallow bowl at the top and
the slenderest of stems below.
But still, the trend does matter. Many champions of free trade and free capital
movements say that world income distribution is becoming more equal as
globalization proceeds, and on these grounds they resist the idea that reducing world
income inequality should be an objective of international public policy. Moreover,
many theories of growth and development generate predictions about changes in
world income distribution; testing them requires information about trends. Indeed, the
neoliberal paradigmwhich has supplied the prescriptions known as the

Washington Consensus (The Washington Consensus is a set of 10 economic

policy prescriptions considered to constitute the "standard" reform package
promoted for crisis-wracked developing countries by Washington, D.C.based
institutions such as the International Monetary Fund (IMF), World Bank, and
the US Treasury Department.[1] It was coined in 1989 by English economist John
Williamson)that have dominated international public policy about development over

the past twenty yearsgenerates a strong expectation that as national economies

become more densely interconnected through trade and investment, world income
distribution tends to become more equal. And it is a fair bet that if presented with the
statement, "World income distribution has become more equal over the past twenty
years" and asked to agree, agree with qualifications, or disagree, a majority of Western
economists would say, "agree" or "agree with qualifications."

The consensus as originally stated by Williamson included ten broad sets of relatively specific policy
recommendations:[1]
1. Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP;
2. Redirection of public spending from subsidies ("especially indiscriminate subsidies") toward
broad-based provision of key pro-growth, pro-poor services like primaryeducation, primary
health care and infrastructure investment;
3. Tax reform, broadening the tax base and adopting moderate marginal tax rates;
4. Interest rates that are market determined and positive (but moderate) in real terms;
5. Competitive exchange rates;
6. Trade liberalization: liberalization of imports, with particular emphasis on elimination of
quantitative restrictions (licensing, etc.); any trade protection to be provided by low and
relatively uniform tariffs;
7. Liberalization of inward foreign direct investment;
8. Privatization of state enterprises;
9. Deregulation: abolition of regulations that impede market entry or restrict competition, except
for those justified on safety, environmental and consumer protection grounds, and prudential
oversight of financial institutions;
10.Legal security for property rights.

If they are right, this would be powerful evidence in favor of the "law
of even development," which says that all national economies gain from more
integration into international markets (relative to less integration), and lower-cost,
capital-scarce economies (developing countries) are likely to gain more from fuller
integration than higher-cost, capital-abundant economies (developed countries).
Developing countries wishing to catch up with standards of living in the West should
therefore integrate fully into international markets (by lowering tariffs, removing trade
restrictions, granting privileges toforeign direct investment, welcoming foreign banks,
enforcing intellectual property rights, and so on) and let the decisions of private
economic agents operating in free markets determine the composition and volume of

economic activities carried out within the national territory. This "integrationist"
strategy will maximize their rate of development; put the other way around, their
development strategy should amount to an integrationist strategythe two things are
really one and the same.

Fortunately, the self-interest of the wealthy Western democracies coincides with this
integrationist strategy for developing countries, because as developing countries grow
richer, their demand for Western products expands and their capacity to absorb their
population growth at home also expands, reducing the pressure on the West created by
surging immigration. The World Bank, the IMF, the World Trade Organization
(WTO), and the other global supervisory organizations are therefore well justified in
seeking to enforce maximum integration on developing countries for the good of all.
What does the evidence show?
Therefore, a lot is at stake in the question of whether world income distribution has
become more, or less, equal over the past twenty years or so. It turns out that there is
no single correct answer, because the answer depends on which combination of
measures one adopts. It depends on (1) the measure of inequality (a coefficient like
the Gini, or quintile or decile (tenth) ratios), (2) the unit of inequality (countries
weighted equally, or individuals weighted equally and countries weighted by
population), and (3) the method of converting incomes in different countries to a
common numeraire (current market exchange rates or purchasing power parity

exchange rates). Treating these as either/or choices yields eight possible measures,
each with some plausibility for certain purposes. Then there is the further question of
what kind of data is usedthe national income accounts or household income and
expenditure surveys.
My reading of the evidence suggests that none of the eight alternative measures
clearly shows that world income distribution has become more equal over the past
twenty years. Seven of the eight show varying degrees of increasing inequality. The
eighththe one that uses the Gini coefficient, countries weighted by population, and
purchasing power parityshows no significant change in world income distribution.
This is because the Gini coefficient gives excessive weight to changes around the
middle of the distribution and insufficient weight to changes at the extremes and
therefore, in this case, gives more weight (than a decile ratio) to fast-growing China;
the use of countries weighted by population has the same effect; and the use of
purchasing power parity tends to raise low incomes more than high incomes,
compared with market exchange rates. Hence this combination generates the least rise
in inequality. But a recent paper by Dowrick and Akmal (2001) suggests that the Penn
World Tables, on which most calculations of purchasing power parity are based (see
Heston and Summers, 1991), contain a bias that makes incomes of developing
countries appear higher than they are. The tables consequently understate the degree
and trend of inequality. When the bias is corrected, even the most favorable
combination of measures shows rising inequality of world income distribution over
the past twenty years, although the trend is less strong than the trend based on any of
the other possible combinations.
It is often said that purchasing power parity measures should always be preferred to
market exchange rates and that countries should always be weighted by population
rather than treated as equal units of observation. Certainly, purchasing power parity
measures are better for measuring relative purchasing power, or relative material
welfare, though the available data are not good enough for them to be more than
rough-and-ready approximations, especially for China and, before the early 1990s, the
countries of the former Soviet Union. But data problems aside, we may also be
interested in income for other purposes. Indeed, for most of the issues that concern the
world at largesuch as migration flows; the capacity of developing countries to repay
foreign debts and import capital goods; the extent of marginalization of developing
countries in the world polity; and, more broadly, the economic and geopolitical impact
of a country (or region) on the rest of the worldthen we should use market exchange
rates to convert incomes in different countries into a common numeraire. After all, the
reason why many poor countries are hardly represented in international negotiations
whose outcomes profoundly affect them is that the cost of hotels, offices, and salaries
in places like New York, Washington, and Geneva must be paid in U.S. dollars, not in
purchasing power parity-adjusted dollars. Using market exchange rates, the

conclusion is clear: all four combinations of measures using market exchange rates
show that world income distribution has become much more unequal.
Causes of increasing inequality
What are the causes of the rise in world income inequality? The theory is not exactly
what one might call watertight; the causality is very difficult to establish. Differential
population growth between poorer and richer countries is one cause. The fall in nonoil commodity pricesby more than half in real terms between 1980 and the early
1990sis another, affecting especially the poorest countries. The debt trap is a third.
Fast-growing middle-income developing countries, seeking to invest and consume
more than can be covered by domestic incomes, tend to borrow abroad; and they
borrow on terms that are more favorable when their capacity to repay is high and less
favorable whenas in a financial crisistheir capacity to repay is low. We saw
repeatedly during the 1980s and 1990s that countries that liberalized and opened their
financial systems and then borrowed heavilyeven if to raise investment rather than
consumptionran a significant risk of costly financial crisis. A crisis pulls them back
down the world income hierarchy. Hence the debt trap might be thought of as a force
in the world economy that is somewhat analogous to gravity.
Another basic cause is technological change. Technological change of the kind we
have seen in the past two decades tends to reinforce the tendency for high-valueadded activities (including innovation) to cluster in the (high-cost) Western economies
rather than disperse to lower-cost developing countries. Silicon Valley is the
paradigm: the firms that are pioneering the collapse of distance themselves congregate
tightly in one small space. Part of the reason is the continuing economic value of tacit
knowledge and "handshake" relationships in high-value-added activities.
Technological change might be thought of as distantly analogous to electromagnetic
levitationa force in the world economy that keeps the 20 percent of the world's
population living in the member countries of the Organization for Economic
Cooperation and Development (OECD) comfortably floating above the rest of the
world in the world income hierarchy. If we have world economy analogues of gravity
and electromagnetism, can the world economy analogue of relativity theory be far
behind?
Consequences
Income divergence helps to explain another kind of polarization taking place in the
world system, between a zone of peace and a zone of turmoil. On the one hand, the
regions of the wealthy pole show a strengthening republican order of economic
growth and liberal tolerance (except toward immigrants), with technological
innovation able to substitute for depleting natural capital. On the other hand, the

regions of the lower- and middle-income poles contain many states whose capacity to
govern is stagnant or eroding, mainly in Africa, the Middle East, Central Asia, the
former Soviet Union, and parts of East Asia. Here, a rising proportion of the people
find their access to basic necessities restricted at the same time as they see others
driving Mercedes.
The result is a large mass of unemployed and angry young people, mostly males, to
whom the new information technologies have given the means to threaten the stability
of the societies they live in and even threaten social stability in countries of the
wealthy zone. Economic growth in these countries often depletes natural capital and
therefore future growth potential. More and more people see migration to the wealthy
zone as their only salvation, and a few are driven to redemptive terrorism directed at
the symbolic centers of the powerful.
Reorienting international organizations
The World Bank and the IMF have paid remarkably little attention to global
inequality. The Bank's World Development Report 2000: Attacking Poverty says
explicitly that rising income inequality "should not be seen as negative," provided the
incomes at the bottom do not fall and the number of people in poverty falls or does
not rise. But incomes in the lower deciles of world income distribution have probably
fallen absolutely since the 1980s; and one should not accept the Bank's claim that the
number of people living on less than $1 a day remained constant at 1.2 billion
between 1987 and 1998, because the method used to compute the figure for 1998
contains a downward bias relative to that used to compute the figure for 1987.
Suppose, though, that the incomes of the lower deciles had risen absolutely and the
number of people in absolute poverty had fallen, while inequality increased. The
Bank's view that the rise in inequality should not be seen as a negative ignores the
associated political instabilities and flows of migrants thatall notions of justice and
fairness and common humanity asidecan harm the lives of the citizens of the rich
world and the democratic character of their states.
The global supervisory organizations like the Bank, the IMF, the WTO, and the
United Nations system should be giving the issue of global income inequality much
more attention. If we can act on global warmingwhose effects are similarly diffuse
and long termcan we not act on global inequality? We should start by rejecting the
neoliberal assumption of the Bretton Woods institutions over the past two decades,
now powerfully reinforced by the emergent WTO, that development strategy boils
down to a strategy for maximum integration of each economy into the world
economy, complemented by domestic reforms to make full integration viable. The
evidence on world income distribution throws this assumption into questionas does
a lot of evidence of other kinds. International public policy to reduce world income

inequality must include a basic change in the policy orientation of the World Bank, the
IMF, and the WTO so as to allow them to sanction government efforts to impart
directional thrust and nourish homegrown institutional innovations.

Suggestions
for
further
reading:
Steve Dowrick and Muhammad Akmal, 2001, "Explaining Contradictory Trends in Global Income Inequality: A Tale
of Two Biases," Faculty of Economics and Commerce, Australian National University.
Alan Heston and Robert Summers, 1991, "The Penn World Tables (Mark 5): An Expanded Set of International
Comparisons,
1950-1988," Quarterly
Journal
of
Economics (May),
pp.
327-68.
Dani Rodrik, 2001, "The Global Governance of Trade as if Development Really Mattered" (unpublished).
Amartya Sen, 2001, "If It's Fair, It's Good: 10 Truths About Globalization,"International Herald Tribune, July 1415.
Robert Hunter Wade, 1990, Governing the Market: Economic Theory and the Role of Government in East Asia's
Industrialization (Princeton
University
Press.
,
2001a,
"Winners
and
Losers," Economist, April
28.
, 2001b, "Globalization and world income distribution: trends, causes, consequences, and public policy"
(unpublished, July).