The inquiry into the effects of globalization has centred around many socio-economic and political aspects. One such aspect of interest to the researchers has been the steady rise in global income inequality since the 1980s. It is generally argued that, besides the domestic factors, this has been the result of “globalization” (Cornia, 1999; Palma, 2006; Naranpanawa & Bandara, 2012).
The impact of globalization on inequality is attributed in the literature to various channels, like skill biased technical change (SBTC) or neo-liberal policies which are used to integrate with the world economy. It is, however, often argued that mechanisms through which globalization affects inequality are country-specific and time-specific, reflecting a great heterogeneity of countries and the nature and timing of their trade reforms (World Economic Outlook, 2007, Chapter 4). The examination of various mechanisms seems to suggest that one of the possible solutions to offset the adverse effect of globalization on income inequality is the government intervention through fiscal measures. This has two different explanations in the literature in terms of “compensation” principle and “efficiency” theory. While the former advocates an increased welfare spending by the government to compensate for risks and negative economic externalities such as job losses and increased income inequality that emerged from the competitive nature of the global economy, the latter view recognizes the budgetary constraints of the government under conditions of increased global economic integration and, thus, advocates a negative relationship between increasing level of global economic integration and welfare spending.
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