An economy that works together, stays together

Source: Steve Breen / Creators Syndicate

The US economy is experiencing its slowest recovery in 70 years. We just can’t seem to give the economy the kick-start it needs. Why? Because we are held back by inequality. Only by tackling inequality head-on can we secure the sustained economic recovery that we are looking for.

Inequality sends a signal about the economy’s potential to grow today. Income among the poorest can be stagnant if people have given up looking for a job because opportunities are so scarce. The recent fall in US unemployment masks record falls in the participation rate, the number of people actually looking for a job. Fewer people in the labour force leads to lower per head growth rates and lower social cohesion. We are wasting our best resource – people. 

Source: Chan Lowe / Tribute Content Agency

Inequality also matters for the economy’s growth potential tomorrow. Richer families can afford to spend more time with their children, investing in their learning and development. Poorer families, who are more likely to work longer hours in minimum wage jobs, simply don’t have the time. But if you think that talent is randomly distributed, then this means that many children's potential will be left untapped. These young people are also more likely to drop out of high school or college, either because of cost or because they simply don't believe that people like them can succeed. This impacts on their ability to secure a job and makes it more likely that they will also fall on hard times.  

What can be done? If inequality is defined as a gap, then let’s build bridges that enable people to close this divide. Raising the minimum wage would enable everyone to earn a basic income. On-the-job training would improve career progression and lifetime income for those in work, and back-to-work training would improve job prospects for those out of work. A more progressive tax and social security system would provide much-needed resources to low-income families to invest in themselves. 

None of these policies constitute a hand-out. Raising the wage, for example, would actually increase tax receipts and reduce welfare expenditure as fewer people require income support. All of these policies can help children as much as adults. For example, women who joined the workforce following welfare reform in the UK spent the extra income earned on books and activities for their children. And each one would increase the productive potential of the economy. An economy that can produce more is likely to grow.  

Brazil's World Cup still half empty

Source:  Fédération Internationale de Football Association

As many on social media have pointed out, the World Cup 2014 emblem looked like a man hanging his head in shame (Figure 1).*

Not the shame that came from losing 7-1 to Germany (though that was pretty painful). The shame that came from knowing that hosting the World Cup reportedly cost the country $4.2 billion but more than half of Brazilians believed it would hurt the economy. That 50 per cent of Brazilians thought now was a bad time to find employment despite the government saying that the World Cup would create 710,000 jobs. That the number of poor people living in Brazil could have filled its World Cup stadiums 30 times over.**

After the dust settles, and the spotlight dims, the facts will re-emerge. The International Monetary Fund forecasts that the Brazilian economy will grow by 1.8 per cent this year, compared to a 10-year average of 3.5 per cent, because of weakness in manufacturing, consumer spending and export performance. Others are more bearish still. The central bank has raised interest rates in recent months, because of above-target inflation, leading to worries that economic growth will be choked off. Social discontent led to a number of high-profile protests in the months leading up to the World Cup.   

Brazil appears to have lost grip on the solid macroeconomic framework it established over the last decade. This platform generated high single-digit growth rates, funded active redistribution policies and contributed to a rapid fall in inequality. Between 2004 and 2012, poverty rates more than halved from 22 per cent to 9 per cent. Conditional cash transfer programs that provided monetary rewards in exchange for attendance at school and health centres improved outcomes for those on the lowest incomes. Between 1999 and 2009, the increase in per capita income of the poorest 10 per cent was nearly four times that of the richest 10 per cent. Out of a general rise in income, grew a substantial middle class.

This middle class is now demanding action. Brazil needs to take this opportunity to re-establish its credibility and tackle the hard problems that are preventing it from achieving sustainable and inclusive growth. It needs to push forward on much-needed reforms to infrastructure that would reduce local bottlenecks and improve the quality, not just quantity, of public education and healthcare. It needs to tackle wasteful corruption, which is estimated to cost between 1.4 and 2.3 per cent of GDP a year, and enables favours to the 'haves' at the expense of the 'have-nots'.         

Brazil will play host to the Olympics in Summer 2016. It is likely that between now and then we will see more protests from a discontented population. But, if the country undertakes substantive reform, we may also see a very different country when the spotlight returns.

* The green hands form the shape of a head, which is held in the yellow hand
** Author's calculation based on data from the World Bank and the Stadium Guide

An earthquake on inequality is coming….

In the debate about rising inequality, the behaviour of Chief Executive Officers (CEOs) has been cited as a major cause.  They are accused of putting short-term (shareholder) interests ahead of long-term (firm) interests.  Their actions are hardly surprising considering that CEO remuneration has historically been tied to short-term objectives such as annual shareholder returns.

But are politicians equally guilty of short-termism?  Consider that their time horizon is the electoral cycle.  Their objective is to be re-elected.  Their method is policies that target the median voter.  A problem that, until recently, affected only a minority, is unlikely to be adequately addressed by the political process.  Cue civil society.  Over the past few years, as a direct response to the discontent caused by rising inequality, we have seen the emergence of the Occupy movement, the UK Living Wage campaign and the Arab Spring. 

Grass-root movements have a long history of affecting change in the United States and beyond.  Giving women the right to vote in the UK, the campaign for equal rights in the US, the fall of the Berlin Wall in Germany.  Activists were drawn together by a shared set of principles, which helped spread their reach and eventually spurred national and global campaigns. 

But in generating a sufficient mass, they also drew the attention of political parties.  The slow rumblings of discontent transformed into substantive political pressure, that forced the hand of politicians into declaring an active policy response.  Such events mimic the “stick-slip” dynamics of an earthquake, where the forces below the earth’s surface eventually generate enough strength to push against the forces holding the plates together, to produce an earthquake (Jones and Baumgartner (2012)).  In this case, the political system with its procedures, rules and norms acts as a retarding friction against the public movements that generate information about pressing issues of the day that require action.

 

The rise of the Occupys, the election of Bill de Blasio to Mayor of New York on an agenda of tackling inequality, the rejection of the Conservative-led coalition in recent UK elections, all suggest that the time is ripe for a major political earthquake.  Yet, the world is still waiting for a major set of policies to resolutely tackle income inequality in the US and beyond.  In the language of our earthquake analogy, what further information is required to overcome such political frictions, taking into consideration the time horizon over which politicians operate? 

First, dispelling the myth that monetary and fiscal stimulus have put the economy on a path of stable, inclusive growth and that no further action is required.  In the US, the wealthiest one per cent captured 95 per cent of post-financial crisis growth between 2009 and 2012, while the bottom 90 per cent became poorer (Oxfam (2014)). The vulnerabilities that formed the basis of the 2008 financial crisis still exist and could generate another crisis in the near-term.  

 

Second, agreeing that reducing inequality can be growth enhancing, as the IMF has strongly argued.  Elections have been won and lost on the state of the economy.  The 2015 election in the UK and the 2016 Presidential election in the US will be no different.      

Third, an acceptance that, because of the nature of technological progress that is driving rising income inequality, for the first time, our children could be worse-off than us (Kotlikoff and Sachs (2012)).  This, unlike the first two, may fall outside of a politician's traditional time horizon, but is surely the strongest argument for action.