SEPTEMBER 2007 :: COVER STORY : ECONOMICS

Exporting Inequality
In Developing Countries, Wages Grow, but So Does the Gap Between Rich and Poor

BY BOB DAVIS, JOHN LYONS AND ANDREW BATSON
The Wall Street Journa

A decade ago, the globalization of commerce promised to be a boon to low-wage workers in developing nations. As wealthy nations shed millions of jobs making apparel, electronics and other goods, economists predicted that low-skilled workers in Latin America and Asia would benefit because there would be greater demand for their labor-and better wages.

In some ways, globalization delivered as promised. In developing countries around the world, globalization-defined as trading and participating in the global economy-has created a vibrant middle class that has elevated the standards of living for hundreds of millions of people. That's particularly true in China, where the incomes of low-skilled workers have consistently risen. The poor in countries like Vietnam and elsewhere in Southeast Asia have also benefited greatly since those countries have opened their economies. In many developing countries around the world, life expectancies and health care have improved, as have educational opportunities.

But there was an unexpected consequence. As trade, foreign investment and technology have spread, the gap between economic haves and have-nots has frequently widened, not only in wealthy countries like the U.S. but in poorer ones like Mexico and China as well.

Many economists now say that the biggest winners by far are those with the education and skills to take advantage of new opportunities, leaving many others lagging far behind. Incomes of low-skilled workers may rise, but incomes of skilled workers rise a lot faster.

The widening gap is raising questions about how much inequality countries can bear, and whether these gaps could ultimately produce a backlash that will undermine freer trade around the world.

Follow the Leader

Many developing nations seem to be following in the footsteps of the U.S., where the income gap has grown sharply since the early 1970s. A 2006 study of Latin America by World Bank economists found that the income divide deepened after economic liberalization in nine of the 12 countries examined.

While that could partly be explained by Latin America's slow rate of economic growth, income gaps are widening in fast-growing Asian nations as well, including Thailand and India. They have even grown in the past decade in South Korea, a country long known for an egalitarian commitment to education.

Then there's China. One of the fastest-growing economies in the world has generated significant wage gains for rank-and-file workers. Yet income inequality is also growing because of the huge gains being posted by the upper crust. From 2000 to 2005, per-capita income of the bottom 10% of urban households in China rose 26% while those at the top saw gains of 133%.

The consequences of widening income inequality are profound. Those without much education or skills often find themselves stuck in jobs in the underground economy that don't pay health-care or pension benefits. That has boosted emigration to better-off regions domestically or to the U.S. and Europe, where anti-immigrant sentiment is surging. Growing inequality also feeds social tensions and the populist argument that globalization is a sucker's game that benefits only the elites.

In Latin America, that sense of alienation has powered populist presidential candidates who won in Ecuador, Bolivia, Nicaragua and Venezuela and came close to carrying Mexico last year. In China, the ruling Communist Party worries that support for liberalization could crumble. The government needs to "safeguard social fairness and justice and ensure that all of the people share in the fruits of reform and development," says Chinese Premier Wen Jiabao.

How Does It Happen?

How does globalization boost inequality? The question is too fresh to have definitive answers, but it's clear that international competition forces local businesses to add skilled workers who can handle newer technology, and shed workers who can't. Foreign firms bring new technology to developing nations and boost demand there for skilled workers by paying 10% to 20% more than domestic firms, says Dirk Willem te Velde, a researcher at the Overseas Development Institute in Britain.

Access to education also plays an important role. Developing nations rarely crank out enough college-trained workers to match growing demand, boosting the wages for fresh graduates. Unskilled workers who get laid off can't find retraining and add to the pool of workers looking for low-wage work.

The effects of globalization are vividly on display in Puebla, Mexico, a lively city of 1.5 million. Located between the port city of Veracruz and Mexico City, Puebla has long been a center of trade and textiles. As with the rest of Mexico, its industries were protected after World War II by high walls of tariffs and quotas, and by restrictions on foreign investment.

During the 1970s, those barriers helped produce rapid economic growth, but the system collapsed in a deep recession that swept through Latin America in the 1980s. To restart the economy, Mexico began dismantling its import barriers in the mid-1980s and tied itself tightly to the world economy through the North American Free Trade Agreement, or Nafta, with the U.S. in 1994. Several other trade treaties have followed since then.

At the time, Mexico's politicians and economists predicted that globalization would produce many new jobs in Mexico, especially for those at the bottom, as companies that produced goods with low-skill labor set up factories south of the border.

For a time, that turned out to be true. Towel maker Industrias Cobitel picked up two big new U.S. customers after Nafta and doubled the number of production workers to 250 by 2000. Exports accounted for 40% of the company's sales in 2000, about the triple the percentage before Nafta. Business was so brisk that many employers didn't care whether new hires had much schooling.

But foreign investment and competition also prompted more demand for skilled labor. Local companies that had gotten by with outdated machinery either upgraded or closed.

Volkswagen, Puebla's largest private employer, has had an especially large impact on the local economy. For years, VW produced Beetles on an old-fashioned, labor-intensive production line where dents were banged out with mallets. But as Mexico opened its economy, VW demanded more of its work force.

The company started building the New Beetle in Puebla in 1998 and followed with other models aimed at hard-to-please U.S. buyers. New machinery was imported. Now welds are done by lasers. Robots paint the exteriors of cars for an even finish. In the past decade, the company has doubled the number of engineers to 700 and is planning to add 100 more this year. They make between $400 and $600 a week and are college graduates.

At the same time, VW slashed its Puebla work force by about 15% since 2000 to 14,000, mostly eliminating assembly jobs, and outsourced production of seats, steering wheels and wire harnesses to other factories. Assembly workers at those factories are paid about one-third the $225 a week VW line workers make. Many auto-parts companies won't hire laid-off VW workers, figuring they can't make the financial adjustment.

Ricardo Mosqueda Martinez lost his job at VW and worked for a time at a parts supplier. "When I first saw the paycheck, I thought to myself, is this a joke?" he says. He didn't last long there. Like many other VW employees, he ended up in Puebla's informal economy, working as a taxi driver and doing other jobs.

New Opportunities

For Puebla locals with the right education, globalization has opened opportunities that were absent in Mexico just a decade ago. Victor Pasilla, the son of a hospital security guard, makes $600 a week designing oxygen sensors for a Puebla start-up, Biomedical Integral, which hopes to build neonatal surgical beds for export. "It has been a big leap," says Mr. Pasilla. "My parents are quite proud that their children are moving upwards."

The surge of well-to-do residents has changed Puebla's look. In the once-poor south of the city, housing developments have opened for young families who have become eligible for mortgage financing. There are also two new shopping malls with international clothing stores, including Zara and Massimo Dutti.

Low-paid textile or auto-parts workers don't shop at Zara, although many now frequent the local Wal-Mart store, which offers food, clothing and appliances at good prices. Low-wage workers live as they have for many years, in cramped urban tenements ringed with razor wire to keep out thieves.

Part of Mexico's problem is that U.S. manufacturers looking for bargain prices have rerouted orders to China, where wages are even lower. But China's success in attracting such jobs doesn't fully explain the puzzle of growing global income inequality. While low-wage Chinese workers have benefited, it's elite workers who have benefited most. In part, that's because the companies in China doing work for overseas markets usually look for a set of skills few Chinese have, such as foreign-language fluency and technical knowledge.

Investment by Japanese and Korean companies has transformed the coastal city of Dalian, with crumbling slums and boarded-up factories giving way to new shopping malls and fancy apartment complexes. But the accompanying surge in real-estate prices has made Dalian nearly unaffordable for lower-paid Chinese workers, who often complain that they are being pushed out of the city.

Such social tensions have become an increasing political problem for the Communist Party, whose power depends on its ability to deliver a broad improvement in people's standard of living. Wary of being labeled as favoring an urban elite, leaders have this year expanded social programs for the poorest and campaigned against wealthy people who flout tax and family-planning laws.

Expanded education can ease inequality, as more workers qualify for skilled jobs. Since 2000, for instance, Puebla State Popular Autonomous University, a large private university, has added undergraduate degrees in such specialties as bionics, electronics and software and is planning to add degrees in biotechnology, power-grid administration and plastics.

Another major factor: So many Puebla natives have given up on their hometown and migrated to the U.S. that competition has eased somewhat for lower-skilled jobs. The greater number of Poblanos working abroad has also increased the amount of cash being sent back home, boosting the incomes of many residents.