Why Haven’t Global Markets Reduced Inequality?

An alternative theory to comparative advantage

In the public lecture “Why Haven’t Global Markets Reduced Inequality?” Eric Maskin, Albert O. Hirschman Professor in the School of Social Science, asks: Why does inequality persist between rich and poor in developing countries? The theory of comparative advantage predicts that globalization should cause inequality in emerging economies to fall. However, this has not been true of the current globalization (even though the prediction held up well for previous such episodes), contradicting the theory of comparative advantage. An article about his lecture appears below.

Globalization has come with many promises, said Eric Maskin, Albert O. Hirschman Professor in the School of Social Science in his October 27 lecture “Why Haven’t Global Markets Reduced Inequality?” including the assurance that it would bring prosperity and growth to poor countries. “On this count I think it’s fair to say that there’s been some success—in the cases of China and India, quite spectacular success,” said Maskin. “But another promise often made on behalf of globalization is that it will reduce the gap between the rich and poor, the haves and the have-nots in developing countries. Here I don’t think globalization has delivered what was promised.”

According to Maskin, the persistent inequality between rich and poor in developing countries in the face of globalization is surprising because it contradicts the theory of comparative advantage, which originated more than two hundred years ago with the British economist David Ricardo and which Maskin described as “the most secure theory we have in economics for explaining international trade patterns.”

The theory of comparative advantage (the twentieth-century formulation is known as the Heckscher-Ohlin model) has “explained many historical trade patterns very well,” Maskin said, but it also “predicts quite unambiguously that free trade should reduce inequality in poor countries.” While the theory proved accurate when trade between the United States and Europe took off toward the end of the nineteenth century (inequality fell in Europe, which had a relative abundance of low-skill labor compared to the United State’s higher proportion of high-skill workers), the theory “is clearly inadequate for explaining the patterns of globalization we face today,” Maskin said.

The theory of comparative advantage also predicts that the bigger the difference in the skill-ratio—the number of low-skill workers per high-skill workers—between two countries, the more trade will occur between those countries. Yet Maskin observes, “The very poorest countries of the world have been almost entirely left out of globalization.”

To explain these conflicts with the standard theory, Maskin outlined an alternative theory he has been working on with Michael Kremer, Gates Professor of Developing Countries at Harvard University and Senior Fellow at the Brookings Institution. The motivation for Maskin and Kremer’s model is the observation that recent globalization has to a large extent meant the globalization of the production process. Their theory explores the implications of cross-border production, in which a single product can be manufactured out of components made and assembled in different countries, or designed in one country and manufactured in another.

A major reason behind the increase in inequality in poor countries, according to the theory, is the different effect globalization has on the job opportunities—the potential “matches”—of workers of different skills. The model implies that globalization will typically open up more options for moderately to highly skilled workers, while actually reducing options for workers with the lowest skills.

The Maskin-Kremer theory also explains why the very poorest countries have been excluded from globalization: if the skills levels in a rich country are sufficiently different from those in a poor country, then international production efforts that employ workers from both countries will be rendered too inefficient to compete effectively in the global market.

“If the theory I have outlined is correct—and I should emphasize that it is one of several theories that are too new to have been thoroughly tested yet—then there is a clear implication for policy,” said Maskin. “The right response is not to try to stop globalization—it probably couldn’t be stopped even if we wanted it to be—but rather to invest in the training and education of the lowest-skill workers, the poorest people of the world, which will alllow them to share in the benefits of globalization.”——Kelly Devine Thomas, Editorial Director

Eric Maskin, Albert O. Hirschman Professor in the School of Social Science from 2000–11, received a Nobel Prize for laying the foundations of mechanism design theory. He also has made contributions to game theory, contract theory, social choice theory, political economy, and other areas of economics.