Many political pundits see widening income disparities as the key factor in the Brexit vote and associate these with a single cause — globalisation. There is no doubting that income distribution within individual countries has become more unequal in recent decades, but is globalisation the main culprit?
Thomas Piketty’s heavy-weight tome Capital in the Twenty-first Century had astonishing success because it rode the zeitgeist: everyone could see that those at the top of the pile were minting it — and flaunting it. Piketty just gave chapter and verse to confirm this. But Piketty didn’t lay the blame on globalisation: his main cause was the patrimonial society, and if anything, globalisation should expose the fat cats to more competition.
The latest offering in the ongoing income-disparity debate is from the always-thoughtful McKinsey Global Institute: ‘Poorer than their parents? A new perspective on income inequality’. Whereas Piketty focused on the very top of the income pyramid, McKinsey looks at what has happened to the whole spectrum, income-group by income-group. In the six advanced countries studied in detail, two-thirds of income-groups had no increase in income during the decade 2005-2014. This is not quite the same as saying that individuals had no increase, because some people shifted between income-groups. But the message is clear: stagnant incomes were not confined to the poorest segment of society: middle-income groups also did badly.
The punch line is that this is the new normal. Gone are the days when just about everyone would be better off than their parents, with the promise of similar advances for their children. In the previous decade, almost all groups became better off.
The social implications are obvious. Social cohesion is much easier if people feel that things are getting better and, whatever life’s struggles, their children will be better off. This promise is now in question. This, surely, is a big part of the explanation for the Brexit discontent: anti-immigration was just the human manifestation. But what role did globalisation play?
This stagnation in low/middle incomes is, in itself, not a new story, but McKinsey disaggregates the generality to explain what happened, perhaps identifying the part played by globalisation.
First thing to note: there are big differences between countries. This is crucial: the dismal general picture may not be so inevitable if some countries have done much better than others. Almost everyone in Italy was in the ‘no better off’ group, while in Sweden only around 20% were in this category.
So why did some countries do better than others?
The first clue is in the 2008 global financial crisis and its aftermath. All the countries studied had a recession and a slow recovery, but some handled this better than others. Italian GDP is now 8% lower than before the crisis. No surprise, then, that almost no-one in Italy is better off. Sweden instituted active policies to keep employment from falling after the crisis and avoided fiscal austerity and its GDP rose 15% over the decade, so there was a bigger GDP pie to go around.
Thus the first requirement in avoiding the bleak future foreseen by McKinsey is to dodge a recession and, if you have one, implement active policies to speed the recovery. Nothing very new here, but this provides half the explanation without mention of the current bête noir of ‘globalisation’.
Feeble GDP recovery, however, was not the only factor. Keeping with the comparison of Italy and Sweden, both had serious adverse demographic changes (fewer people of working age). Again, it’s hard to blame globalisation for this. But it’s also harder to correct through macro-policy, so the gloomy prognosis stands for countries with substantial population ageing and no political support for immigration. Sweden’s preparedness to accept refugee immigration will help it here.
In just about all countries the distributional problems were made more serious by structural changes which began much earlier. Wage-earners share of GDP has fallen by around 10 percentage points over the past 25 years. In the US, the fall in the wage share is about the same as the OECD average, but has been much sharper since around 2000. In addition, prime-age men dropped out of the labour force.
Globalisation must explain some of this. China has become ‘manufacturer to the world’, displacing conventional manufacturing in advanced economies, and the well-paid, secure jobs it involved. McKinsey notes that between 1980 and 2010, competition for low- and medium-skill jobs became global, with 85 million workers in emerging economies joining the labour force in export-related activities. Global competition undercut labour’s bargaining position and diminished the opportunity for industry ‘rent seeking’ in protected industries, which had often benefited unionised labour. Union membership fell just about everywhere.
But globalisation was not the only factor in the diminished wage share. The International Labour Office cites ‘financialisation’ as being at least as important — ‘sharp-pencil’ managerial pressures for greater productivity which weakened labour’s bargaining position. Globalisation might have put extra pressure on management for efficiency gains, but much of this pressure originated elsewhere, particularly from stronger shareholder pressure and economy-wide deregulation.
Earlier analysis had explained the falling wage share largely in terms of technological progress (smarter ways of doing things, with more sophisticated tools: robots replaced humans). The ILO gives this lower importance although the anecdotal evidence is compelling. Germany has retained a big manufacturing sector, but employment in manufacturing has fallen nearly as much as elsewhere. In any case, labour-shedding technological advance would have occurred even without globalisation.
The nature of production changed, with more low-income services, typically creating low-paid part-time jobs. So too investment changed, with Google and Facebook requiring little in the way of big factories with blue-clad workers bent over their machines. Whatever ill effect these seismic changes had on the demand for unskilled labour, it’s hard to blame globalisation.
In short, globalisation was not by any means the only factor, although it played an important role. The standard response is that more must be done to help those left behind. The McKinsey report fills in some important detail here. It may not be too surprising to learn that tax/transfer policies helped overall income distribution in Sweden during this slow-growth period (so that almost no-one was worse off), but such policies did just as much in the US (e.g. through extension of unemployment benefit eligibility). Before taxes and transfers, 80% of the income-groups had no increase in income, but after tax and transfers, this fell to 20%. Thus redistributive measures have been important in softening the greater income disparity, even in free-market America.
So what are the lessons?
First, don’t have a financial crisis. The optimistic interpretation of this period is that the crisis was the result of clearly identifiable mistakes (inadequate prudential supervision of finance which allowed an asset bubble to form in fragile and overextended financial sectors in the main advanced economies). Competent policy would avoid repeating these mistakes.
Second, use active counter-cyclical polices when necessary. The crisis-affected economies had a pathetically weak recovery, exacerbated in 2010 in Europe by the secondary crisis in the peripheral countries, whose debt problems reflected policy failure.
Third, GDP growth is needed if aspirations are to be met. Abandoning the huge benefits that globalisation has brought would be throwing out the baby with the bathwater. It’s hardly surprising that everyone understands that post-Brexit, the UK will still be a great outward-looking trading nation, because there is no sensible alternative. No-one is suggesting putting the Yorkshire journeymen back behind their hand-looms. But if the Trans Pacific Partnership is any indication, globalisation is under pressure in America.
There are lessons, too, about the best ways to soften the impact of globalisation (and technology). Tax/transfers are clearly part of the story, but there are limits to how far this can be pushed without distorting incentives. Mendicants don’t generally enjoy their status. Better to find employment for those left behind, even subsidising this through negative income-tax. Industry policy may be making a comeback (see speeches by the new UK PM), but governments have a bad record at picking winners, and the incentives need to be general rather than project-specific (the dead-end nature of our submarine project provides an example of what to avoid). Education is the key to offering life-enhancing progress up the ladder.
When there is enough perspective to evaluate Brexit objectively, it will be judged to have been a failure of politics to play its core role in reconciling different views — a triumph of emotion over rationality. And the nefarious side of globalisation will be seen as a minor blemish. Good policy can still deliver the social glue of equitable outcomes.
Photo courtesy of Flickr user Philipp Lücke