Inequality in the OECD: causes and policy responses

Inequality has become a ‘big’ topic in recent years, of concern both to economists and the public at large. This is exemplified by the popularity of Thomas Piketty’s Capital in the Twenty-First Century, and many other works. I have written on some of these studies here.

They continue to be churned out: in the July issue of the heterodox Cambridge Journal of Economics, Pasquale Tridico of Roma Tre University analyses the determinants of income inequality in 25 OECD countries between 1990 and 2013. He finds that ‘financialisation’, increased labour market flexibility, the declining influence of trade unions and welfare state retrenchment have been key to its rise.

When other factors such as economic growth, technological change, globalization and unemployment are taken into account, the above four causes remain important, and, to the extent that they can be changed as a matter of policy, they can mitigate inequality without harming economic growth. They are therefore not the full story but, for example, the negative effects of rising unemployment on inequality can be reduced if there is a strong social safety net in place. Continue reading

A sustainable labour market: what kind of structure?

A sustainable labour market structure, at industry-wide and national levels, should enable the productive efficiency of the economy to grow over time, and promote at the same time high levels of employment and low levels of unemployment. In a modern democracy, mass unemployment is unsustainable because it represents a tremendous level of waste, and also because it is likely to create social unrest and can undermine the very foundations of such a democracy. Governments may not always be able to ‘control’ the economy such that mass unemployment is banished for ever, as the current economic crisis has made clear, but they can pursue policies which banish it for considerable periods of time, and should do so.

Measures of economic growth record the increase in the production of goods and services in an economy over time. But growth is a complex process and involves a change in the structure of production over time as well. Companies and industries fail and can disappear altogether while new ones start up and develop. Jobs likewise ‘disappear’ both within such companies and industries, as well as within growing companies. New jobs are at the same time created across the economy. The balance between the two over time determines whether employment levels rise or fall.

As Geoff Harcourt has argued, in theory a ‘rigid’ labour market with industry-wide wage setting behaviour by trade unions is not incompatible with a dynamic economy. If wages are set at some uniform rate across an industry, those (less successful) firms with inferior techniques and low and declining profits will be forced out of business quicker without being able to cut their workers’ wages, while those more successful firms with superior techniques of production and higher profits will be able to sustain and expand investment and output without being hindered by flexible wage-setting behaviour forcing wages higher. Inferior techniques will be scrapped more quickly and resources will be re-allocated towards superior techniques of production. Economic growth and structural change can in this theory proceed apace.

I have been wondering about the more orthodox view that regards flexible wages across the economy as important facilitators of structural change and growth. In this theory, less successful and failing firms will be forced and able to cut wages to maintain profit levels, while more successful and profitable firms will be able to raise wages. In fact, they will want to raise wages to attract more labour as they invest and expand output. Workers are likely to respond to the different wage levels as a market signal, and apply for jobs at the firm which offers higher wages. Competition will prevent the failing firms from cutting wages too far, for fear that they will lose their workforce to rival firms, or even firms in a different and more successful industry. In a way similar to the ‘rigid’ wage-setting behaviour outlined in the paragraph above, the dispersion of wage levels across an industry and even the whole economy will have limits set in this case however by the forces of competition in the labour market as well as the market for firms’ output. In the first case, wage-setting is more institutionalised by trade unions, in the second it is market-driven. But the outcome of both cases does not seem too dissimilar in theory.

In theoretical terms then, institutionalised wage-setting in a market economy need not imply a stagnation of output caused by inhibited structural change. It is highly simplistic to argue that trade unions by themselves and in all cases cause unemployment and slow economic growth. Cross-country case studies would seem to suggest this. The Scandinavian economies have in general been successful in recent years, while maintaining strong welfare states and, I believe, trade union movements of significance. The large economies of France, Germany and Italy have to varying degrees suffered from high unemployment for decades now, and many economists have come to accept that labour and product market ‘rigidities’ have been the cause of this. Personally I would add restrictive monetary and fiscal policies maintained over long periods, and the costs, both static and dynamic, of German reunification. Economists need to take a subtle approach to recommending structural ‘reform’ to these governments. And these governments need to be bolder, in the face of economic crisis, with their macroeconomic policies, to prevent unemployment rising more than it needs to in the medium and longer term.

A sustainable labour market structure then, can be compatible with the presence of trade unions, especially those that accept that structural change is part of the dynamic of economic growth and development. Other ‘rigidities’ may or may not be compatible with this dynamic and labour market regulations and structures require close study before recommendations are made for blanket reforms which could sweep away those institutions that sustain social cohesion and also promote the very dynamism that economies need to grow.