Development

How can growth reduce equality?

Lucas STONE (2016), University College of London, Msc Management.

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Inequality is neither intrinsically positive or detrimental. Its meaning has been distorted in our veneration of the free market, but some level of inequality is necessary. It provides the “carrot and stick” mechanism of motivation- the desire to excel is brought about by the allure of absolute and relative wealth. However, such benign inequality depends on participants having an equal position on the starting line of this race to the top. The power of a meritocracy to drive a workforce is undermined when income inequality translates into wealth inequality and eventually inequality of opportunity. In the words of Beatrice Webb “the possession of wealth, and especially the inheritance of wealth, seems almost invariably to sterilise genius.” (Webb 1926)

Some economists assume that this latter manifestation of inequality is a price worth paying for maximum economic growth- an ideology known as neoliberalism. This view dictates that business and investment- terms that have become political euphemisms for the rich- should be the primary engines of development, as this will create the strongest economic growth. Wealth must then inevitably trickle down from the most to least wealthy. In short: maximize growth and the rest will take care of itself through the omnipotent free market.

Economic growth becomes an end in itself. However, there is evidence that when growth is employed as an economic tool to further social betterment, there are two positive effects. It unsurprisingly results in a more equitable society. However, it crucially also results in stronger growth. The possibility that we could have our cake (growth) and eat it (equality) undermines the neoliberal trade-off between “perfect equality and perfect efficiency”. Growth could be the sea that raises all boats equally. The IMF notes: “if the income share of the top 20 percent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth.” (Dabla-Norris et al. 2015)

In reality, there is no one-size-fits-all answer to whether such a trade-off between growth and equality exists. Instead, it depends on the growth-promoting policy or trend itself. In some instances they are synergistic, in others they conflict. However, three factors- technology, globalisation, and government policies- contribute to economic growth, but stand out for their potential to seriously impair current and future equality, even when set in regions with radically different political and economic histories. This essay will explore how these factors, which theory dictates should promote equality; in practice have the opposite effect.

Technology

SImon Kuznets’ hypothesis devised in the ‘50s claims that technological advances curtail the income inequality brought about by industrialization. This may be applicable to developing countries but now in advanced economies we are in uncharted territory. Erik Brynjolfsson of the MIT Sloan School of Management cites the link between productivity and employment to pinpoint the exact point at which we exit the scope of the Kuznetz curve, which only addresses technologies that complement rather than compete with human productivity. He found that the two were positively correlated until 2000, where productivity continues unabated but employment suffers a precipitous drop. Brynjolfsson attributes this “great decoupling” to technology (Rotman 2013).

Although technological advances stimulate growth, according to Brynjolfsson and colleagues: “Machines are substituting for more types of human labor than ever before.” (Brynjolfsson et al. 2014) It is a familiar idea that the automation of processes makes workers in low skilled jobs obsolete, but technology is swiftly encroaching on white-collar turf as well: “professions such as law, financial services, education, and medicine” may quickly succumb to non-human alternatives (Rotman 2013). Technological growth is putting many low- and middle- skill workers out of a job.

So, who is benefitting? Brynjolfsson envisions an ideas economy where a “creative class” reaps disproportionate rewards. This centres around a process of “capital deepening” such as predicted by Thomas Picketty in his book “Capital in the Twenty-first Century”. He asserts that when the returns from capital are greater than the general level in an economy as a whole, the share of national income spent on capital will rise (Brynjolfsson et al. 2014). This is coming to pass because of the substitution of human labour by machines, a lucrative form of capital. However, where Picketty anticipates an increase in the fortunes of “owners of ordinary capital”, Brynyolfsson assumes that his creative class, particularly those who are adept at creating “digital capital” such as software, will prosper at the expense of labour and holders of ordinary capital in the coming of what he terms “the second machine age”.

Membership of the creative class is supposed to be predicated on intelligence, leading The Economist to proclaim a “triumph of the meritocracy” in the tech industry (Economist 2014). This claim is important to examine, because a meritocracy is underpinned by equality of opportunity. Although it is true that “you can’t program a computer or develop an app without a high IQ”, it is equally true that “a specialised education” is essential (The Economist 2014).

The danger is that the need for this education could create a “technology premium”- a chasm between the incomes of those who are highly intelligent but also specifically technologically literate, and an educational underclass that are not. The key difference between an educational, and specifically technological premium is that its effect of the destruction of lower-skilled work is a higher demand for expertise, which in turn attracts more workers and feeds the industry. These workers are more likely to come from an affluent background that can afford a technological education. If social mobility is depicted as a ladder, the creative class is climbing up (usually from a middle rung) and pulling it up after themselves. This dynamic could make technological growth highly exclusive.

Globalisation

Classical economic theory dictates that trade globalisation should induce growth but reduce inequality. British political economist David Ricardo supposed that the free movement of capital entailed by globalisation should push up the price of low-skilled labour. This is because of the comparative advantages of advanced and developing economies. Advanced economies produce high-skilled labour efficiently, whereas developing nations have an abundance of low-skilled labour. Global integration pools labour markets together, giving advanced economies access to a cheap labour source and increasing its demand. This is epitomized in what Brynjolfsson calls Apple’s “8 word business plan”: “Designed by Apple in California. Assembled in China.” (Brynjolfsson et al. 2014) However, although global inequality has fallen over the last two decades and average income has risen, within many countries it has increased (The Economist 2012, World Bank 2014).

Nobel laureate Eric Maskin and Professor Michael Kremer proposed their theory of “skills matching” to delineate this trend. They assert that financial globalisation has perturbed a constructive relationship between skilled and low-skilled workers in developing countries. In the absence of trade, the low-skilled worker’s productivity was enhanced by proximity with a skilled individual, for example a manager. Growth-promoting foreign direct investment into poor countries to exploit cheap labour disrupts this association. In a localized brain drain, skilled workers migrate to multinationals for superior wages. The productivity of their former subordinate drops as do their wages by consequence. The low-skilled partner cannot follow suite because said multinationals have higher standards even for their low-skill workforce. (Garlock 2015) Technology exacerbates this effect. Developing nations have a relatively high number of low-skilled workers whose function could be automated. These nations will lose their aforementioned competitive advantage to the rising tide of technology. The cost to equality will be great- many low-skilled workers will be excluded from globalisation-driven growth.

Government Policies

Government policies often disproportionately represent the interests of a rich minority that embezzles economic growth. In regard to redistributive policies the IMF reports: “rising pre-tax income concentration at the top of the distribution in many advanced economies has also coincided with declining top marginal tax rates.” (Dabla-Norris et al. 2015) Though the evidence that redistribution is harmful to growth is limited to extreme cases, tax systems are becoming more regressive because of vested interests. (Ostry et al. 2014) The Institute for Fiscal Studies found that George Osborne’s 2015 budget would “make the poorest tenth of families in the country around £800 a year worse off by 2019.” (Chu 2015)

Legislation that favours business over workers also fosters inequality. Flexible labour markets allow businesses to become more dynamic in the face of uncertain demand. This stimulates growth. However, it also entails a curtailing of workers rights. A business must be able to hire and fire as it pleases, and pay its workers what the market dictates labour is worth. If the labour market is left to its own devices in this way, businesses inflate their bottom line, whereas workers form a class of precarious proletariats- “precariats”. This is particularly true of low-skilled workers, who preemptively pool their bargaining power into trade unions. The IMF found strong evidence that deunionization decreases the incomes of low- and middle- earners. (Jaumotte and Buitron 2015) This is as expected as it naturally precipitates a surge of unprotected labour, such as zero-hours contracts in the UK. The OECD states “since the mid-1990s, more than half of all job creation was in the form of non-standard work.” (OECD 2015) Non-standard workers are true “precariats” who the OECD reports are “worse off in many aspects of job quality, such as earnings, job security, or access to training”. (OECD 2015) Deunionization surprisingly also boosts the top 10%’s share as well. (Jaumotte and Buitron 2015) Looser labour markets do provide growth, but these dual consequences signify an important driver of inequality.

Labour regulation also brings about inequality if it is not enforced stringently. This is the case in developing countries, which may have strict labour regulations, but violations are not punished. This results in large informal economies “where around 60 per cent of workers find income opportunities” according to the WTO. (WTO 2009) Informality is an exaggerated case of non-standard work, so a correlation was similarly found between higher rates of informality and income inequality. They found that the effect of growth on the informality rate is either positive or at least benign. In this context growth can cause inequality.

The state is also responsible for financial regulation (or lack thereof). The OECD states that “over the past 50 years, credit by banks and other institutions to households and businesses has grown three times as fast as economic activity.” (OECD 2015) Rather than being indicative of a uniform demand for the expansion of finance, this reflects the influence of society’s wealthiest who have a greater capacity to benefit. The OECD reports: “credit expansion fuels income inequality as the well-off gain more than others from the investment opportunities they identify.” Also, financial deregulation is lucrative for workers in the financial sector who “In Europe […] make up 20% of the top 1% earners”. (OECD 2015) For these reasons, finance-fuelled growth tends to line the pockets of society’s wealthiest.

An excess of finance simultaneously foments instability causing an increased likelihood of financial crises. This began with the rise of neoliberal thinking in the 70’s and 80’s, which according to The New Statesman has led us into “42 years of neoliberal crises- with one every seven years, on average [which] followed 44 years of Keynesian stability” (Wilby 2015) Part of deregulation is leniency towards credit overexpansion and insufficient capital buffers, exemplified in the 2008 crisis. These are predicated on the promises of government assistance for institutions deemed “too-big-to-fail (TBTF)”. Such guarantees implicitly encourage risky behavior- it is not the risk-takers who really suffer, but those who rely on the provision of public goods. These are swiftly retracted when the government must rescue TBTF institutions. Within this paradigm of privatized profit and socialized risk, the poor underwrites the risk of financial crises but are excluded from the preceding economic growth. The OECD concurs: “The long-term costs from credit overexpansion fall disproportionately on the socially vulnerable” (OECD 2015) The IMF asks where developing economies fit into this framework. They lack the financial depth of advanced economies, but theory and empirical evidence suggest that the rich still benefit the most from “financial development [which] boosts top incomes the most in the early stages of development.” (Dabla-Norris et al. 2015)

Effective state provision of health, retirement security, and education allows inclusive growth. None of these is a panacea, but education supersedes the others in its capacity to level the playing field of opportunity.

Education through technology could preclude a technology premium by democratizing the way we learn. Massive Open Online Courses (MOOCs) are widely available, but tech startup “Udacity” offers shorter, programming-related “nanodegrees”. Interestingly, it uses AI analysis to “increase their [the courses’] retention and completion”. (The Economist 2015) This demonstrates that technological innovation can revolutionise education, allowing growth to proceed in an inclusive manner. The intellectually demanding nature of technological fields demands some inequality of opportunity due to differences in intelligence, but the aim should ultimately be free access to education in pursuit of a meritocracy.

Globalisation presents a trickier problem due to a lack of incentives. There is a huge demand for technologically literate workers and the private sector has stepped in to confer suitable skills to an already educated workforce. The workers cut out of globalisation due to the high standards of foreign firms are of a much less skilled. There is no incentive for the private sector to waste resources on workers who lack a basic level of education. It is therefore the obligation of the state and NGOs in emerging economies to arm laborers with skills necessary to participate in the global economy.

Finally, education can subvert the monopoly of the wealthy on political power. Lobbying and subtler derivatives allow economic and political power to become synonymous. Evidence for this can be found in Professors Martin Gilens and Benjamin Page’s renowned study, which found that the U.S. is a corporate oligarchy. (Gilens and Page 2014) Within this framework, the wealthy employ their economic muscle to forge a political climate that is favourable to maintaining wealth. This is evidenced by patterns of deunionisation and increasingly regressive redistributive regimes. However, vested interests can only be brought to fruition through a sympathetic and malleable government. An educated population is more likely to employ their votes in a way that truly serves their interests. These interests should be progressive redistribution, controlled unionisation, and financial regulation to facilitate stable, long-term, and inclusive growth. Financial regulation is particularly relevant in emerging economies that have the chance to heed the omens of financial disasters in the developed world, and repudiate the fallacy that there is a trade-off between financial regulation and development.

Growth frequently has the potential to cause inequality. If unfettered, it will fester in the wood of the ladder of social mobility until the core is rotten and to ascend is impossible. The best cure at our disposal is education, which will allow growth to be the sea that raises all boats, not just million dollar yachts.

References

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