Tag: inequality

Policymakers around the world have used Gross Domestic Product as the main gauge of economic performance – and have often adopted policies that aim to maximise its rate of growth. Generation after generation of economists have committed significant time and effort to thinking about the factors that influence GDP growth, on the premise that an expanding and healthy economy is one that sees its GDP increasing every year at a sufficient rate.

But is economic output a good enough indicator of national economic wellbeing? Costanza et al (2014) (see link below) argue that, despite its merits, GDP can be a ‘misleading measure of national success’:

GDP measures mainly market transactions. It ignores social costs, environmental impacts and income inequality. If a business used GDP-style accounting, it would aim to maximize gross revenue — even at the expense of profitability, efficiency, sustainability or flexibility. That is hardly smart or sustainable (think Enron). Yet since the end of the Second World War, promoting GDP growth has remained the primary national policy goal in almost every country. Meanwhile, researchers have become much better at measuring what actually does make life worthwhile. The environmental and social effects of GDP growth is a misleading measure of national success. Countries should act now to embrace new metrics.

The limitations of GDP growth as a measure of economic wellbeing and national strength are becoming increasingly clear in today’s world. Some of the world’s wealthiest countries are plagued by discontent, with a growth in populism and social discontent – attitudes which are often fuelled by high rates of poverty and economic hardship. In a recent report titled ‘The Living Standards Audit 2018’ published by the Resolution Foundation, a UK economic thinktank (see link below), the authors found that child poverty rose in 2016–17 as a result of declining incomes of the poorest third of UK households:

While the economic profile of UK households has changed, living standards – with the exception of pensioner households – have mostly stagnated since the mid-2000s. Typical household incomes are not much higher than they were in 2003–04. This stagnation in living standards for many has brought with it a rise in poverty rates for low to middle income families. Over a third of low to middle income families with children are in poverty, up from a quarter in the mid-2000s, and nearly two-fifths say that they can’t afford a holiday away for their children once a year. On the other hand, the share of non-working families in poverty has fallen, though not by enough to prevent an overall rise in poverty since 2010.

Their projections also show that this rise in poverty was likely to have continued in 2017–18:

Although the increase in broad measures of inequality were relatively muted last year, our nowcast suggests that there was a pronounced rise in poverty (measured after housing costs[…]. The increase in overall poverty (from 22.1 to 23.2 per cent) was the largest since 1988. But this was dwarfed by the increase in child poverty, which rose from 30.3 per cent to 33.4 per cent. […]The fortunes of middle-income households diverged from those towards the bottom of the distribution and so a greater share of households, and children, found themselves below the poverty threshold.

A simple literature search on Scope (or even Google Scholar) shows that there has been a significant increase in the number of journal articles and reports in the last 10 years on this topic. We do talk more about the limitations of GDP, but we are still using it as the main measure of national economic performance.

Is it then time to stop focusing our attention on GDP growth exclusively and start considering broader metrics of social development? And what would such metrics look like? Both interesting questions that we will try to address in coming blogs.

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Questions

  1. What are the main strengths and weakness of using GDP as measure of economic performance?
  2. Is high GDP growth alone enough to foster economic and social wellbeing? Explain your answer using examples.
  3. Write a list of alternative measures that could be used alongside GDP-based metrics to measure economic and social progress. Explain your answer.

The median pay of chief executives of the FTSE 100 companies rose 11% in 2017 to £3.93 million per year, according to figures released by the High Pay Centre. By contrast, the median pay of full-time workers rose by just 2%. Given two huge pay increases for the CEOs of Persimmon and Melrose Industries of £47.1 million and £42.8 million respectively, the mean CEO pay rose even more – by 23%, from £4.58 million in 2016 to £5.66 million in 2017. This brings the ratio of the mean pay of FTSE 100 CEOs to that of their employees to 145:1. In 2000, the ratio was around 45:1.

These huge pay increases are despite criticisms from shareholders and the government over excessive boardroom pay awards and the desire for more transparency. In fact, under new legislation, companies with more than 250 employees must publish the ratio of the CEO’s total remuneration to the full-time equivalent pay of their UK employees on the 25th, 50th (median) and 75th percentiles. The annual figures will be for pay starting from the financial year beginning in 2019, which for most companies would mean the year from April 2019 to April 2020. Such a system has been introduced in the USA this year.

So why has the gap in pay widened so much? One reason is that there is no formal mechanism whereby workers can apply downward pressure on such awards. Although Theresa May, in her campaign to become Prime Minister in 2016, promised to put workers on company boards, the government has since abandoned the idea.

Executive pay is awarded by remuneration committees. Membership of such committees consists of independent non-executive directors, but their degree of independence has frequently been called into question and there has been much criticism of such committees being influenced by their highest paying competitors or peers. This has had the effect of ratcheting up executive pay.

Then there is the question of the non-salary element in executive pay. The incentive and bonus payments are often linked to the short-term performance of the company, as reflected in, for example, the company’s share price. In a period when share prices in general rise rapidly – as we have seen over the past two years – executive pay tends to rise rapidly too. A frequent criticism of large UK businesses is that they have been too short-termist. What is more, bonuses are often paid despite poor performance.

There has been some move in recent years to make incentive pay linked more to long-term performance, but this has still led to many CEOs getting large pay increases despite lack-lustre long-term performance.

Then there is the question of shareholders and their influence on executive pay. Despite protests by many smaller shareholders, a large proportion of shares are owned by investment funds and their managers are often only too happy to vote through large executive pay increases at shareholder meetings.

So, while the pressures for containing the rise in executive pay remain small, the pay gap is likely to continue to widen. This raises the whole question of a society becoming increasingly divided between the few at the top and a large number of people ‘just getting by’ – or not even that. Will this make society even more fractured and ill at ease with itself?

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Questions

  1. How would you set about establishing whether CEOs’ pay is related to their marginal revenue product?
  2. To what extent is executive pay a reflection of oligopolistic/oligopsonistic behaviour?
  3. In what ways can game theory shed light on the process of setting the remuneration packages of CEOs? Is there a Nash equilibrium?
  4. What are the advantages and disadvantages of linking senior executives’ remuneration to (a) short-term company performance; (b) long-term company performance?
  5. What is/are the best indicator(s) of long-term company performance for determining the worth of senior executives?
  6. Consider the arguments for and against capping the ratio of CEOs’ remuneration to a particular ratio of either the mean or median pay of employees. What particular ratio might be worth considering for such a cap?

The IMF has just published its six-monthly World Economic Outlook. This provides an assessment of trends in the global economy and gives forecasts for a range of macroeconomic indicators by country, by groups of countries and for the whole world.

This latest report is upbeat for the short term. Global economic growth is expected to be around 3.9% this year and next. This represents 2.3% this year and 2.5% next for advanced countries and 4.8% this year and 4.9% next for emerging and developing countries. For large advanced countries such rates are above potential economic growth rates of around 1.6% and thus represent a rise in the positive output gap or fall in the negative one.

But while the near future for economic growth seems positive, the IMF is less optimistic beyond that for advanced countries, where growth rates are forecast to decline to 2.2% in 2019, 1.7% in 2020 and 1.5% by 2023. Emerging and developing countries, however, are expected to see growth rates of around 5% being maintained.

For most countries, current favorable growth rates will not last. Policymakers should seize this opportunity to bolster growth, make it more durable, and equip their governments better to counter the next downturn.

By comparison with other countries, the UK’s growth prospects look poor. The IMF forecasts that its growth rate will slow from 1.8% in 2017 to 1.6% in 2018 and 1.5% in 2019, eventually rising to around 1.6% by 2023. The short-term figures are lower than in the USA, France and Germany and reflect ‘the anticipated higher barriers to trade and lower foreign direct investment following Brexit’.

The report sounds some alarm bells for the global economy.
The first is a possible growth in trade barriers as a trade war looms between the USA and China and as Russia faces growing trade sanctions. As Christine Lagarde, managing director of the IMF told an audience in Hong Kong:

Governments need to steer clear of protectionism in all its forms. …Remember: the multilateral trade system has transformed our world over the past generation. It helped reduce by half the proportion of the global population living in extreme poverty. It has reduced the cost of living, and has created millions of new jobs with higher wages. …But that system of rules and shared responsibility is now in danger of being torn apart. This would be an inexcusable, collective policy failure. So let us redouble our efforts to reduce trade barriers and resolve disagreements without using exceptional measures.

The second danger is a growth in world government and private debt levels, which at 225% of global GDP are now higher than before the financial crisis of 2007–9. With Trump’s policies of tax cuts and increased government expenditure, the resulting rise in US government debt levels could see some fiscal tightening ahead, which could act as a brake on the world economy. As Maurice Obstfeld , Economic Counsellor and Director of the Research Department, said at the Press Conference launching the latest World Economic Outlook:

Debts throughout the world are very high, and a lot of debts are denominated in dollars. And if dollar funding costs rise, this could be a strain on countries’ sovereign financial institutions.

In China, there has been a massive rise in corporate debt, which may become unsustainable if the Chinese economy slows. Other countries too have seen a surge in private-sector debt. If optimism is replaced by pessimism, there could be a ‘Minsky moment’, where people start to claw down on debt and banks become less generous in lending. This could lead to another crisis and a global recession. A trigger could be rising interest rates, with people finding it hard to service their debts and so cut down on spending.

The third danger is the slow growth in labour productivity combined with aging populations in developed countries. This acts as a brake on growth. The rise in AI and robotics (see the post Rage against the machine) could help to increase potential growth rates, but this could cost jobs in the short term and the benefits could be very unevenly distributed.

This brings us to a final issue and this is the long-term trend to greater inequality, especially in developed economies. Growth has been skewed to the top end of the income distribution. As the April 2017 WEO reported, “technological advances have contributed the most to the recent rise in inequality, but increased financial globalization – and foreign direct investment in particular – has also played a role.”

And the policy of quantitative easing has also tended to benefit the rich, as its main effect has been to push up asset prices, such as share and house prices. Although this has indirectly stimulated the economy, it has mainly benefited asset owners, many of whom have seen their wealth soar. People further down the income scale have seen little or no growth in their real incomes since the financial crisis.

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Questions

  1. For what reasons may the IMF forecasts turn out to be incorrect?
  2. Why are emerging and developing countries likely to experience faster rates of economic growth than advanced countries?
  3. What are meant by a ‘positive output gap’ and a ‘negative output gap’? What are the consequences of each for various macroeconomic indicators?
  4. Explain what is meant by a ‘Minsky moment’. When are such moments likely to occur? Explain why or why not such a moment is likely to occur in the next two or three years?
  5. For every debt owed, someone is owed that debt. So does it matter if global public and/or private debts rise? Explain.
  6. What have been the positive and negative effects of the policy of quantitative easing?
  7. What are the arguments for and against using tariffs and other forms of trade restrictions as a means of boosting a country’s domestic economy?

Each January, world political and business leaders gather at the ski resort of Davos in Switzerland for the World Economic Forum. They discuss a range of economic and political issues with the hope of guiding policy.

This year, leaders meet at a time when the global political context has and is changing rapidly. This year the focus is on ‘Creating a Shared Future in a Fractured World’. As the Forum’s website states:

The global context has changed dramatically: geostrategic fissures have re-emerged on multiple fronts with wide-ranging political, economic and social consequences. Realpolitik is no longer just a relic of the Cold War. Economic prosperity and social cohesion are not one and the same. The global commons cannot protect or heal itself.

One of the main ‘fissures’ which threatens social cohesion is the widening gap between the very rich and the rest of the world. Indeed, inequality and poverty is one of the main agenda items at the Davos meeting and the Forum website includes an article titled, ‘We have built an unequal world. Here’s how we can change it’ (see second link in the Articles below). The article shows how the top 1% captured 27% of GDP growth between 1980 and 2016.

The first Guardian article below identifies seven different policy options to tackle the problem of inequality of income and wealth and asks you to say, using a drop-down menu, which one you think is most important. Perhaps it’s something you would like to do.

Articles

Project Davos: what’s the single best way to close the world’s wealth gap? The Guardian, Aidan Mac Guill (19/1/18)
We have built an unequal world. Here’s how we can change it World Economic Forum, Winnie Byanyima (22/1/18)
Oxfam highlights sharp inequality as Davos elite gathers ABC news, Pan Pylas (21/1/18)
Inequality gap widens as 42 people hold same wealth as 3.7bn poorest The Guardian, Larry Elliott (22/1/18)
There’s a huge gender component to income inequality that we’re ignoring Business Insider, Pedro Nicolaci da Costa (22/1/18)
Ahead of Davos, even the 1 percent worry about inequality Washington Post, Heather Long (22/1/18)
“Fractures, Fears and Failures:” World’s Ruling Elites Stare into the Abyss GlobalResearch, Bill Van Auken (18/1/18)
Why the world isn’t getting a pay raise CNN Money, Patrick Gillespie and Ivana Kottasová (1/11/17)

WEF archive
Articles on Inequality World Economic Forum

Questions

  1. Distinguish between income and wealth. In global terms, which is distributed more unequally?
  2. Why has global inequality of both income and wealth grown?
  3. Explain which of the seven policy options identified by the Guardian you would choose/did choose?
  4. Go through each one of the seven policy options and identify what costs would be associated with pursuing it.
  5. Identify any other policy options for tackling the problem.

The latest edition of the IMF’s Fiscal Monitor, ‘Tackling Inequality’ challenges conventional wisdom that policies to reduce inequality will also reduce economic growth.

While some inequality is inevitable in a market-based economic system, excessive inequality can erode social cohesion, lead to political polarization, and ultimately lower economic growth.

The IMF looks at three possible policy alternatives to reduce inequality without damaging economic growth

The first is a rise in personal income tax rates for top earners. Since top rates have been cut in most countries, with the OECD average falling from 62% to 35% over the past 30 years, the IMF maintains that there is considerable scope of raising top rates, with the optimum being around 44%. Evidence suggests that income tax elasticity is low at most countries’ current top rates, meaning that a rise in top income tax rates would only have a small disincentive effect on earnings.

An increased progressiveness of income tax should be backed by sufficient taxes on capital to prevent income being reclassified as capital. Different types of wealth tax, such as inheritance tax, could also be considered. Countries should also reduce the opportunities for tax evasion.

The second policy alternative is a universal basic income for all people. This could be achieved by various means, such as tax credits, child benefits and other cash benefits, or minimum wages plus benefits for the unemployed or non-employed.

The third is better access to health and education, both for their direct effect on reducing inequality and for improving productivity and hence people’s earning potential.

In all three cases, fiscal policy can help through a combination of taxes, benefits and public expenditure on social infrastructure and human capital.

But a major problem with using increased tax rates is international competition, especially with corporation tax rates. Countries are keen to attract international investment by having corporation tax rates lower than their rivals. But, of course, countries cannot all have a lower rate than each other. The attempt to do so simply leads to a general lowering of corporation tax rates (see chart in The Economist article) – to a race to the bottom. The Nash equilibrium rate of such a game is zero!

Videos

Raising Taxes on the Rich Won’t Necessarily Curb Growth, IMF Says Bloomberg, Ben Holland and Andrew Mayeda (11/10/17)
The Fiscal Monitor, Introduction IMF (October 2017)
Transcript of the Press Conference on the Release of the October 2017 Fiscal Monitor IMF (12/10/17)

Articles

Higher taxes can lower inequality without denting economic growth The Economist, Buttonwood (19/10/17)
Trump says the US has the highest corporate tax rate in the world. He’s wrong. Vox, Zeeshan Aleem (31/8/17)
Reducing inequality need not hurt growth Livemint, Ajit Ranade (18/10/17)
IMF: higher taxes for rich will cut inequality without hitting growth The Guardian, Larry Elliott and Heather Stewart (12/10/17)

IMF Fiscal Monitor

IMF Fiscal Monitor: Tackling Inequality – Landing Page IMF (October 2017)
Opening Remarks of Vitor Gaspar, Director of the Fiscal Affairs Department at a Press Conference Presenting the Fall 2017 Fiscal Monitor: Tackling Inequality IMF (11/10/17)
Fiscal Monitor, Tackling Inequality – Full Text IMF (October 2017)

Questions

  1. Referring to the October 2017 Fiscal Monitor, linked above, what arguments does the IMF use for suggesting that the optimal top rate of income tax is considerably higher than the current OECD average?
  2. What are the arguments for introducing a universal basic income? Should this depend on people’s circumstances, such as the number of their children, assets, such as savings or property, and housing costs?
  3. Find out the details of the UK government’s Universal Credit. Does this classify as a universal basic income?
  4. Why may governments reject the IMF’s policy recommendations to tackle inequality?
  5. In what sense can better access to health and education be seen as a means of reducing inequality? How is inequality being defined in this case?
  6. Find out what the UK Labour Party’s policy is on rates of income tax for top earners. Is this consistent with the IMF’s policy recommendations?
  7. What does the IMF report suggest about the shape of the Laffer curve?
  8. Explain what is meant by tax elasticity and how it relates to the Laffer curve?