How to End Hard Times? Reduce Inequality

A new report from a United Nations group details how low inequality promotes economic growth — and blasts away at a status quo where the most profitable firms end up to be those that most ruthlessly drive down wages.

By Salvatore Babones

A major new report from the United Nations Conference on Trade and Development  has identified income inequality as one of the main culprits behind continuing economic stagnation in America, Europe, and throughout the world.

The 2012 UNCTAD Trade & Development Report evaluates the role played by income inequality and the shift in income from workers to investors in today’s economic malaise. The study concludes that “reducing inequality through fiscal and incomes policies is key for growth and development.”

Unfortunately, inequality is everywhere been on the rise.[pullquote]The percentage share of worker’s wages as a proportion of total national income is sinking throughout the developed world.[/pullquote]

The percentage share of worker’s wages as a proportion of total national income, the new UNCTAD report finds, has fallen by more than 5 points in most English-speaking countries and by more than 10 points in much of continental Europe.

Total income in most major economies has grown dramatically over the past twenty years, but wage income has not. The result? Investors are becoming richer and richer relative to wage-earners in the same countries.

Of course, inequality among wage-earners is also rising, especially in the United States, where income inequality hit a new record high in 2011.

The UNCTAD report, subtitled Policies for Inclusive and Balanced Growth, finds that policies “that preserve the share of workers in national income and redistribute income through progressive taxation and public spending would improve equality as well as economic efficiency and growth.”

In 200 pages of dense economic analysis, the report lays out a detailed roadmap for sustained growth based on high wages and low inequality.

First, link “the growth rate of average wages and … the minimum wage to the overall performance of the economy as measured by overall productivity growth.” In other words, workers’ wages should be linked to the overall performance of the economy.[pullquote]In the United States, real economic output has more than doubled over the past forty years, yet wages have remained flat.[/pullquote]

In the United States, real economic output per person has more than doubled over the past forty years, yet median workers’ wages have been absolutely flat. The real minimum wage has actually declined, from $10.55 per hour (in today’s dollars) in 1968 to just $7.25 today.

A U.S. minimum wage benchmarked to productivity growth, as the UNCTAD report recommends, would now be over $21 per hour. The one developed country that avoided the 2008 global financial crisis — Australia — has minimum wages in this range.

The second ingredient for sustained growth: adjust wages for inflation. The UNCTAD report emphasizes that wages must keep pace with expected inflation, not past inflation.

The expected inflation rates used to adjust wages should be based on the targets set by central banks. The US Federal Reserve began setting formal inflation targets earlier this year. The Fed’s current target inflation rate is 2 percent per year.

Ever since the mid-1970s the Fed has argued against incorporating inflation expectations into wage agreements. The UNCTAD report argues that this was a mistake “based on static neoclassical economic reasoning.”

Based on a detailed examination of the evidence from the past three decades, the report finds that when “wages in an economy rise in line with average productivity growth plus an inflation target … the economy as a whole creates a sufficient amount of demand to fully employ its productive capacities.”[pullquote]High inequality inhibits growth and is preventing our recovery from the worst economic downturn of the past seventy years.[/pullquote]

Third, and most provocatively, the UNCTAD report finds that low inequality promotes economic growth and high inequality hinders growth. It recommends that “as far as possible … the wage level for similar qualifications [should be] similar throughout the economy, and … not left to the discretion of individual firms.”

The reasoning behind this claim: Flexible labor markets encourage firms to compete by reducing wages rather than by investing in new facilities and new technologies.

When wages are uniform across firms and sectors, the most profitable firms are those with the best products and services. Unproductive firms are weeded out in the never-ending process of creative destruction.

On the other hand, when wages differ dramatically across firms and sectors, the most profitable firms are those that are best at driving down wages. This results in a race to the bottom in which everyone loses except the owners of the most miserly firms.

The OECD and other pro-market organizations have long argued that “flexible” labor market arrangements are good for employment. Policies that reduce minimum wages, encourage part-time work, make it easy to fire people, and limit unemployment benefits have been the standard toolkit of the past three decades.

According to this theory, policies that keep wages low tend to promote full employment. The UNCTAD report, by contrast, argues that “downward adjustments of average real wages leading to greater inequality between profit and wage incomes is an entirely ineffective remedy for unemployment.”

“Greater inequality does not make economies more resilient to shocks that cause rising unemployment. On the contrary, it has made economies more vulnerable.”

High inequality is often portrayed by corporations and politicians as the price we pay for sustained economic growth. The 2012 UNCTAD Trade & Development Report exhaustively demonstrates just how vacuous this argument really is.

High inequality is not a prerequisite for economic growth. It is not even an unfortunate but tolerable by-product of growth. High inequality inhibits growth and is preventing our recovery from the worst economic downturn of the past seventy years.

According to UNCTAD, policies that “redistribute income through progressive taxation and public spending would improve equality as well as economic efficiency and growth.” In other words, to grow the realonomy — the real economy in which ordinary people live, work, and consume — tax and spend. It really is that simple.

Salvatore Babones is a senior lecturer in sociology and social policy at the University of Sydney and an associate fellow at the Institute for Policy Studies.