23 April 2015

We cannot afford to leave behind the losers of globalisation


Markets have been with us since the dawn of civilisation. The Neolithic Revolution, in 9500 BC when the Natufians settled down in the Levant and started cultivating teosinte, the ancestor of maize, really marks the start of market societies – involving specialisation, trade and technology.

Yet the capitalism with which we are familiar – of hyper-mobile labour and capital, and of sprawling footloose multinational companies– is a very modern innovation. The size of the global economy has more than doubled since the start of this century, from $32trn to $78trn last year, yet this new era of globalisation has created a class of losers in developed countries who increasingly look to populist parties for protection. How can they be won back?

One of the enduring strengths of the market system is its resilience and its ability to adapt. As Victoria Bateman wrote in her piece for CapX last week, there is nothing pre-ordained about the system we live within today. Markets are contingent on the design of the institutions behind them, and we have the social, cultural and political tools to shape them to meet the ends that we, as democratic societies, seek. But these tools must be used wisely.

A study last year by Pew Research revealed that about two-thirds of people around the world recognise the benefits of living within a free-market economy, but there is far more optimism in the developing world as they catch-up with the West.

Little Optimism for the Next Generation in Advanced Economies

People in these rising nations see the solution to inequality as lower taxes, and for good reasons. Starting from behind what we call the ‘technological frontier,’ there are plenty of low-hanging fruit for everyone.  This is not so much the case in the West, which faces secular stagnation and where the route to growth is through new ideas rather than the adoption of existing ones.

Returning to the extremes of the tired left-right economic spectrum to which we have tethered our ideas might be a mistake. Its logical consistency breaks down for those who form views on an issue-by-issue basis or when there are changes in the lie of the land.

The 1923 British General Election, which pitted property rights against trade, stands as a case in point. The Conservatives under Stanley Baldwin stood on a platform of tariff-based protectionism, while Labour wanted free trade to reduce the cost of living. Today, Labour is the party of protectionism and the Conservatives are the party of trade and enterprise. Broad political principles are at the mercy of the shifting consequences of the policies to which they are tied. The winners and losers aren’t always the same.

In 2012, the McKinsey Global Institute found growing imbalances in the global labour market. By 2020, they estimate that the world will have up to 95 million more low-skilled workers than employers will need, or an 11% oversupply of such people. In 2013, Carl Frey and Michael Osborne at the Oxford Martin School predicted that 47% of jobs in the US involving “routine manual and cognitive tasks” could be automated by 2025, with even some white-collar administrative occupations at high risk.

New populist parties in Europe garner much of their support from the disenfranchised working class. The anthropologist Karl Polanyi wrote in 1944 that when labour and land, which traditionally ‘were tied up with the organisations of kinship, craft and creed,’ were separated and valued on the market, the losers tend to find solace in extremism. Of course he would underappreciate the role of the free enterprise system in driving prosperity and supporting well-funded public services, but the thrust of his analysis is right.

The death of the secure job-for-life and the sense of community undermined by the free movement of people and capital has pushed those in Britain’s dilapidated coastal towns and France’s post-industrial cities to UKIP and Front National; while anti-market parties Podemos and Syriza are either challenging or have become the mainstream in Spain and Greece.

The solution lies only partly in strengthening education and greater regional investment (McKinsey also expect a 13% global shortfall in graduates by 2020, particularly in science and engineering). But these are long-term approaches to fix labour markets that, in the rich world, have broken down at the low skilled end. (That is, wages have become detached from productivity growth.)

As the oversupply of low-paid unskilled workers persists, employers gain greater buying power over employees, which can lead pay settlements that are lower than the value of staff to the firm. Last year, the Resolution Foundation said that the numbers living on the minimum wage has doubled since it was introduced in 1999, from 600,000 to 1.2 million, or 5% of the workforce. 23% of those on the minimum wage have been stuck on it for at least 5 years, compared to 11% in 2004.

The usual solution for tackling big business – i.e. greater competition – does not adequately address this problem. Creating more demand for low-skilled labour requires diverting resources from higher up the value chain at the cost of growth. While promoting enterprise and allowing creative destruction are extremely important, not everyone will have the aptitude, risk-seeking impulses or access to the upfront capital to take the first step.

The aim, at least in the short-term, has to be maximising the disposable incomes of the poorest workers – and there are two ways to do this: lowering taxes and raising pay. Both are needed but each belongs to different sides of a political fault-line.

Tax cuts for the low-paid have been the main driver of the 2 million jobs created in the UK over the last five years. The Conservative, Liberal Democrat and UKIP parties have committed to raising the threshold at which income tax is levied to at least £12,500, equivalent to an annual salary on the minimum wage. This is just.

While the libertarian argument that one should keep what one earns is willing to ignore the institutional and infrastructural framework provided by the State, the sentiment is sound for those who are essentially shut out of the global economy and whose economic mobility is limited.

Anyone worried about whether this policy undermines the social contract by absolving the section of the population that benefits most from the welfare state from paying for it, should look to the fact that the poor consume almost all of their income and pay taxes at the point of sale – at 20% in the UK. Movement towards a progressive consumption tax would help fund income tax cuts for the poor.

Even still, the pay for many of those who work in the retail, hospitality and catering sectors has been supplemented by tax credits. Citizens UK found that 5.2m low-paid workers were receiving £11bn a year of taxpayers’ money to top up their wages, with a number of retail providers receiving more in what they call ‘hidden subsidies’ than they paid in tax. While the criticism from the traditional Left that these tax credits amount to a corporate handout is not borne out by the academic evidence, we do have a problem of low pay that needs to be tackled.

In the UK, the Living Wage Foundation, a campaign group, has encouraged over 1,300 companies, including HSBC, PwC and Transport for London, to pay a wage which meets the local cost of living (£7.85p/h nationally and £9.15p/h in London). This is a very good start and shows that big companies, whose profit levels have swollen during the recovery, can afford to pay their workers a better wage. But it may not be enough.

All three main parties have planned to raise the minimum wage to £8p/h by 2020. Higher rates should remain sensitive to the effects on employment. They should reflect and track developments in labour productivity – and there needs to be a great push to improve the productivity of the workforce as this ultimately determines living standards. At the same time, taxes for the low-paid should be eliminated.

Business taxes on small firms could be cut to reduce the impact on their cost base while giving them a competitive boost relative to their larger rivals, in a similar way to how the Small Business Bonus Scheme works in Scotland.

Ultimately, the social contract will be undermined if there are large groups of people who work difficult jobs but can’t command from them a minimally acceptable standard of living, either because it is taxed away or because they aren’t paid enough in the first place. Runaway executive-employee pay ratios don’t help either. The serial entrepreneur Nick Hanauer made a convincing moral pro-market case along these lines for Politico Magazine last year.

The 21st century has produced a new set of challenges: a new wave of technological unemployment alongside ageing populations and scarce resources. In seeking out a popular capitalism, we should see as separate the commitment to enterprise, innovation, and empowered communities from the set of policies that are required to achieve them. Alongside lower taxes, reductions in excessive red tape and the promotion of ownership, we should welcome the role of a sensibly higher minimum wage to ensure that the many can have a decent stake in a capitalist society.

Zac Tate is Deputy Editor of CapX