The distributional challenge

by Michael Spence

Assessing the recent past and looking forward to the near term is a natural end-of-year exercise. When it comes to the global economy in 2013 and 2014, it may well be a necessary one as well.

In the past year, systemic risk declined. Europe came together around the need to stabilize the eurozone, with the European Central Bank and Germany playing the leading roles.

China’s leadership transition was completed and a relatively clear policy direction has been established, featuring a more level playing field for the private and state sectors and an expanding — indeed “decisive” — role for markets. Germany’s general election pointed to policy continuity, though an extended period of slow growth and high unemployment seems unavoidable.

Emerging economies (excluding China) were only temporarily destabilized by anticipation of monetary tightening in the United States. They are, however, preparing for a higher-interest-rate world, one marked by a transitional slowdown in growth.

In the U.S., the annual growth rate crept up and unemployment inched down. Widespread public disgust with a polarized, dysfunctional Congress may have contributed to a bipartisan budget agreement and a reduction in political risk. Though it would be premature to announce a trend, one can hope that pragmatism and compromise will prevail over the moral righteousness of political extremes.

No one likes living with second- or third-best alternatives, but that is America’s reality for now.

Looking forward, one can foresee a gradual process of restoring balance sheets and balanced growth patterns in a wide range of economies. But this does not amount to a full recovery.

In Europe, more convergence in unit labor costs and reforms targeting structural adaptability remain on the to-do list. In the U.S., persistent underinvestment in the public sector is the main factor blocking full realization of potential growth.

A recent proposal by the economist Martin Feldstein points in the right direction: funding expanded public sector investment with a short- to medium-term fiscal stimulus in conjunction with a multi-year fiscal-consolidation plan. Whether the new spirit of bipartisanship extends that far remains to be seen; clearly, the political challenge of making credible multi-year commitments remains daunting.

But while cautious optimism may be in order, many advanced and developing countries’ growth patterns — both before and since the 2008 crisis — have underpinned a dramatic shift in income and wealth toward the upper quartile of the distribution. This is not only producing high and rising levels of measured income inequality; it may also be contributing to reduced economic and social mobility and greater inequality of opportunity — arguably an even more serious threat to social cohesion and political stability.

We know some of the causes of these trends. In the U.S., for example, labor-saving technology is reducing routine white- and blue-collar employment across the economy, pushing employment toward nonroutine manual or cognitive activities. This has undoubtedly contributed to downward pressure on household earnings in the middle-income range of the economy’s large nontradable side.

On the tradable side, automation and the shift of middle-range jobs (in terms of value added) to developing countries have caused employment growth to stall, while value added per person and average incomes have grown rapidly.

America’s uneven education system — in which quality is correlated with neighborhood income levels and skills training is out of synch with employers’ rapidly evolving needs — is a second factor fueling higher inequality. This reflects both a public-investment deficiency and an information gap: investing in job training in a rapidly evolving industrial structure is like shooting at a moving target. Given imperfect information about future needs, labor markets are out of equilibrium.

Powerful technological and global market forces are not confined to any single country. The same issues are arising everywhere, with differences in outcomes reflecting variability in market flexibility and social-policy choices.

These adverse trends date back to about 1980. Before that, the postwar pattern of growth showed a much lower divergence between mean and median incomes than many economies are now experiencing. Nor are these trends likely to diminish in the near future.

Ameliorating unfavorable distributional outcomes will inevitably involve either direct market intervention (using, for example, minimum-wage and trade policies) or altering incentives (relying on unemployment insurance and redistribution through the tax system or direct provision of services). Because opportunity is still related to growth, the challenge is to experiment with and design multipronged approaches that achieve, or at least advance, distributional objectives while doing minimal damage to the economy’s structural flexibility and dynamic efficiency.

And here, the perfect must not be allowed to become the enemy of the good.

Most countries attempt to address distributional problems by combining social provision of basic services (like education, skills training and health care) with a minimum wage, progressive income taxation and property taxes (which mitigate adverse incentives associated with high marginal income-tax rates).

In some countries, broadly shared restraint on income and wage growth seems to have been important in restoring competitiveness and boosting potential output.

There are also measures that partly protect domestic tradable industries from external competition or, in the case of the exchange rate and management of the capital account, that alter the terms of trade.

Of course, international agreements limit such measures in order to preserve a relatively open global economy, which yields large aggregate benefits (even as the distribution of benefits and costs remains a challenge for policymakers). And all of these measures have implications for economies’ efficiency and adaptability.

At the end of 2013, one of our age’s great political leaders and campaigners for social and economic justice, Nelson Mandela, passed from our midst.

The pursuit of sustainable patterns of equitable and inclusive growth will be a defining feature of economic policymaking worldwide in 2014 and beyond.

We must hope that business and labor leaders can come together with government, educational establishments and social entrepreneurs to advance this agenda. Mandela’s example and generosity of spirit should be our guide.

Michael Spence, a Nobel laureate in economics, is professor of economics at New York University’s Stern School of Business and Senior Fellow at the Hoover Institution. © 2013 Project Syndicate (www.project-syndicate.org)