28 September 2016

Inequality is a global problem. Here’s how to tackle it

By Linda Yueh

“Inclusive growth” is a frequently heard term as countries grapple with the recent rise in inequality – even as poverty has fallen sharply over the past two and a half decades worldwide.

To give the term meaning requires fashioning growth policies that reduce inequality without resorting to harmful protectionism.

Of course, there is much more to do in order to lift the remaining bottom billion or so out of abject poverty by 2030, as envisaged by the United Nations’ Sustainable Development Goals. Still, the impressive growth of emerging economies in the past two and a half decades has led to inequality between nations falling as poor countries “catch up” to rich ones during an era of globalisation characterised by greater integration of markets.

Because of the relatively faster growth of emerging economies, inequality has fallen across nations. as the income gap has narrowed between developed and developing countries. Yet income inequality globally has been largely unchanged.

That’s because within countries, inequality has generally risen, or else not improved significantly.

Take America. During the economic boom of the 1950s, the top 1 per cent gained a bit more than the rest – grabbing some 5 per cent of income gains.

But since the Great Recession, the top 1 per cent have accounted for 95 per cent of the income gain, leaving the bottom 99 per cent with just 5 per cent of the pie.

Get more from CapX
  Follow us on Twitter
  Like us on Facebook
  Sign up to our email bulletin

Inequality in America has risen so much that the current era has been dubbed a Second Gilded Age: in fact, income inequality has surpassed the peak reached over a century ago.

The problem is less stark elsewhere – but inequality is still an issue for many nations. In Britain and others, growing economic disparity has contributed to a backlash against globalisation and even capitalism itself.

The result is the touting by the new Prime Minister of “inclusive growth”, an idea which has also gained traction in America, where both presidential candidates have focused on the “squeezed” middle class and stagnant wages.

But what’s causing this stagnation?

The rise in income inequality can be traced to a number of factors, including globalisation – but that does not suggest the remedy should be found in trade policy alone.

Even if the overall economy gains from trade, there are certainly distributional effects – some groups will win, others will lose. This will happen even if trade agreements level the playing field for standards – something that the 12-nation trade deal known as the Trans Pacific Partnership, or TPP, does address in part.

Modifying trade deals in this fashion is one avenue, but it’s not enough. Trade policy alone is unlikely to address the myriad of distributional effects from trade. So it is more efficient – and also likely to be more effective – to use domestic policy like taxes and government spending to address inequality.

After all, it’s difficult to disentangle the effects on inequality stemming from trade versus domestic factors, such as technological change that rewards the highly skilled more than those workers in the middle of the skill spectrum.

Regardless of the cause, targeted redistributive policies are more likely to be effective in tackling the unequal effects on incomes.

One example of a fiscal policy that can aid redistribution and economic growth is government-backed investment in infastructure, both hard (airports) and soft (digital). With borrowing costs at a record low, governments in the US, Britain, Japan, Europe and elsewhere don’t have to pay much to raise capital on bond markets, so it’s a good time to invest.

Infrastructure investment could generate better-paid, middle-skilled jobs, as the sector spans manufacturing as well as the digital economy. In that sense, these policies could reduce the inequality that has created the “squeezed middle” and depressed median wages, raising incomes for certain segments of the population without adverse consequences on overall economic growth. Indeed, better infrastructure and helping the middle class who comprise the bulk of consumers are likely to raise growth.

Even though domestic policies are more likely to be successful, the backlash against trade means that future trade agreements and further globalization are becoming more difficult. The global impact is already being felt.

For decades, international trade has helped developing countries “catch up” by giving them links to advanced economies – which have benefited in turn by trading with new markets. World trade growth is thought to lead overall economic growth – and indeed has outpaced the expansion of the global economy for decades.

But now, according to the World Trade Organisation, international trade is growing more slowly than even the sluggish world economy. On current trends, 2016 will see the slowest pace of global trade growth since the 2008 financial crisis.

That’s worrying for global inequality and emerging economies. The burst of foreign direct investment that has accompanied the growth of international trade since the early 1990s is one of the reasons developing countries grew so well that a billion people were lifted out of extreme poverty, reducing some of the gap between them and rich nations in the process.

For governments, tackling global inequality should be mostly a domestic rather than a trading issue. The consequences of the decisions taken on this in major economies will have global repercussions – and may already. For the rest of the world, the stakes are high.

Elsewhere on CapX
  Rapid reforms in ex-communist countries led to higher incomes and more political freedom
  Why free trade is at the top of Obama’s bucket list
  Extreme inequality is the roadblock to prosperity

Linda Yueh is Adjunct Professor of Economics, London Business School and Fellow, St Edmund Hall, University of Oxford.

On Monday Oct 3, she will be speaking at a Centre for Policy Studies fringe event at the Conservative Party Conference titled 'The wealth and poverty of nations? Conservative approaches to global inequality' (12.45 to 2.00pm at the Jurys Inn, 245 Broad Street, Birmingham, B1 2HQ).

Her co-panellists will include Rory Stewart MP, Minister of State, Department for International Development, and Mark Goldring, chief executive of Oxfam GB.