Globalization and inequality after the pandemic

As the COVID-19 crisis eases, reductions in poverty and inequality through improved employment opportunities are at the center of many national strategies for economic recovery. However, as this column warns, inequality may rise as countries double down on global value chains and openness to trade without upskilling the broader workforce.

The sudden economic slowdown resulting from the pandemic and lockdowns has confirmed the importance of global integration and having a more digitally developed infrastructure. COVID-19 has also highlighted existing weaknesses in global integration in the production of goods and interdependence across borders.

Recent studies confirm that the benefits of global value chains still outweigh the costs. But reforms are still needed. Trade experts caution that the absence of critical goods during the pandemic was not only due to production (‘supply-side’) disruptions but also due to the drastic increase in the demand for such goods.

In fact, the evidence arguing for higher global integration and more trade openness remains positive, especially for developing countries as they benefit from increased job creation, higher technological transfers, foreign direct investment, and skills upgrading.

However, not all global value chain linkages are the same. In countries with relatively low levels of digital integration and human capital, and restrictive regulatory policies, integration into global value chains tends to be shallower and to focus on commodities rather than manufacturing goods. Less sophisticated global value chains or global production sharing agreements are likely to have less impact on the creation of more jobs and better jobs.

A clear role for global value chains and digital investments in the post-pandemic recovery phase

As the crisis subsides, reduction in poverty and inequality through more, and better, formal employment is at the center of most economic recovery strategies worldwide. Given the potential for globally integrated firms to grow and create jobs, especially when they focus on more sophisticated products, policy-makers want to know if more trade openness can be part of their recovery strategy.

They also wonder whether deeper integration into global value chains can help improve the current lackluster performance by achieving inclusive growth, as experienced in the years before the pandemic. This is the case in Colombia and many other countries, where policy-makers are evaluating a variety of market reforms as part of their recovery strategy.

New research estimates the potential effects of reforms to promote deeper participation of Colombian firms in global value chains and proposed investments in digital infrastructure. The study estimates the sectoral and geographical impact of distinct reforms to identify potential winners and losers.

Like many developing countries, Colombia is a country that was characterized by high levels of inequality before the pandemic, and where the most vulnerable households – especially workers on the wrong side of the digital divide and/or those engaged in informal jobs – saw their employment opportunities and incomes decline dramatically.

The post-pandemic world offers a window of opportunity for newcomers to connect to existing global production sharing agreements by becoming reliable providers of intermediate inputs and services, as well as key components of final products assembled elsewhere. This is especially important for countries in the Americas, which are geographically closer to the US and European markets.

However, to help Colombian firms integrate better into global production markets, the country needs improvements in its regulatory frameworks for infrastructure and customs service expansion. It also needs reductions in tariff and non-tariff barriers for imports, alongside efforts to make tariffs more homogenous and schedules more stable.

Colombian policy-makers also recognize the need to reduce the costs of logistics and freight transport by modernizing maritime ports and airports, and the removal of barriers to entry for ancillary services provision. There is also a clear understanding of the importance of streamlining foreign direct investment to stabilize net inflows, reducing non-tariff impediments for multinationals, and setting limits on profit repatriation.

Reforms, reforms, reforms…and the centrality of human capital investments

Consistent with other recent studies, the Colombia case shows that while the combination of reforms yields formal job creation, the jobs created do not benefit the poor and most vulnerable. A key reason is that most workers at the bottom of the wage distribution lack the skills to access the types of jobs offered by firms engaged in global production agreements.

Patterns across countries show that as upgrades stemming from joining global agreements come about, wages rise but net employment tends to fall, and gains are concentrated among more skilled workers. For example, women workers benefit from a large share of labor-intensive jobs in countries with those industries, but they often lose out with technology upgrades.

The overall impact of digital infrastructure development on growth through formal employment generation can have a discernible effect on poverty reduction. But inequality may rise due to an increase in the skill premium associated with digital infrastructure development, with more jobs becoming amenable to remote working and distance learning becoming more feasible.

There are some clear lessons for countries contemplating similar approaches. In order to generate inclusive growth through reforms aimed at deepening participation in global production agreements and investments in digital infrastructure, it is imperative to have a parallel set of reforms and investments whereby poorer households can accumulate the human capital needed to access higher quality formal jobs.

A reduction in inequality can come about through a combination of policies that not only create more jobs through better integration into global production but also introduce platforms that enable a broader set of people to improve their skills and to work remotely.

Such an approach could, in principle, create formal jobs for workers in the mid-range of the human capital distribution, as they will be trained to operate more sophisticated technology. It could also create jobs for workers in the lower end of the skill distribution if firms linked to global value chains generate backward linkages - buying intermediate inputs and services from local suppliers; effectively forming domestic value chains, using labor-intensive producers, which supply upstream processes.

 

Author:

Ximena V. Del Carpio is Practice Manager and Lead Economist in the Poverty and Equity Practice Group of the World Bank. While at the World Bank, Dr. Del Carpio has provided policy advice to governments in Latin America and the Caribbean, East Asia and the Pacific, and Europe and Central Asia region. 

José Cuesta is a development economist and an affiliated professor at Georgetown University's McCourt School of Public Policy. His research interests revolve around poverty and conflict economics, specifically the distributive analysis of social policies; intra-household allocation; social protection and labor distortions. 

Maurice D. Kugler is Professor of Public Policy in the Schar School of Policy and Government at George Mason University, with research expertise on the role of new technologies in boosting economic growth and labor productivity (aka endogenous growth theory).