Growing Out of Inequality

Income inequality has been increasing in most major economies – and in many of them, it has been increasing significantly. This is a cause for growing concern, and rightly so: inequality not only can undermine an economy’s long-term growth prospects; it can restrain growth in the short term by depressing aggregate demand.The typical approach to tackling inequality – redistributive tax-and-transfer fiscal policies – can be controversial and divisive, owing to perceived tradeoffs between economic growth and greater equality. The result is usually heated debate and passionate rhetoric, but little concrete action. Politicians are especially prone to this dynamic – as evidenced by much of the conversation about inequality in the ongoing presidential election campaign in the United States.
There is a better way, one that is less controversial and politically more amenable to action: putting in place reforms that promote strong, inclusive growth that by its nature reduces inequality. This approach focuses on reducing inequalities of opportunity and broadening the base of participants in the growth process, thereby ensuring that more people benefit from it. Politicians who champion this approach may find it easier to build winning coalitions to enact it.
The range of policies that can stimulate inclusive growth is broad. It includes improving access to markets, leveling the playing field for large and small firms, investing in human capital, and promoting job creation. Regulatory and institutional reforms that strengthen the rule of law and promote open, competitive, and fair business environments are one example. This agenda also features the development of infrastructure that expands economic opportunities and policies that make it easier to access finance.
Education is a key area to consider when promoting inclusive growth. Improving the availability and quality of education expands the talent pool in the labor force and upgrades and broadens its skills base. Early childhood development programs, for example, have been demonstrated to provide lifelong educational benefits and the foundation for success in the workplace.
Moreover, it is important to remove barriers in the labor market. Greater flexibility is crucial to providing opportunities for an educated workforce to find well-paying jobs – especially when efforts to do so are complemented by macroeconomic policies that boost demand for labor. The removal of barriers to women’s participation in economic activity is another important lever for sparking inclusive growth.
The effectiveness and appropriateness of reforms that promote inclusive growth will differ from place to place. However, few countries lack significant opportunities to strengthen several policies in this area.
To be sure, redistributive fiscal policies often will remain necessary. Nevertheless, it is important that they be designed in a way that causes as little economic harm as possible. Well-designed tax-and-transfer policies may not be inimical to growth – or at least can minimize the efficiency cost of redistribution. On the tax side, examples include expanding the base of the personal income tax, ensuring that the rate structure is progressive, removing excessive and regressive exemptions, and improving property taxation. On the transfer side, they include retooling social safety nets to encourage acquisition of new skills and capabilities (conditional cash transfers are one possibility) and retooling social-insurance programs to eliminate adverse incentives and bolster their breadth and sustainability.
This agenda is all the more important because rising inequality can produce a backlash against globalization and technological change, both of which are major drivers of economic growth. Rather than attempting to restrain them, policies must address their more disruptive effects in a careful and imaginative way, through education and retraining programs, more flexible labor markets that allow workers to adjust to changes in the economic environment, and well-designed safety nets to support them through the process. International cooperation will be key to managing some aspects of globalization, especially regarding taxes on mobile capital.
At a time when the world is concerned with both slowing economic growth and rising inequality, policies that can be simultaneously pro-growth and pro-equality merit close consideration. It is time to stop trying to re-slice the pie and start ensuring that it gets bigger in a more inclusive way, so that there is more to go around and more people get a slice.

4th Year • October 16 – November 15 2015 • No. 32

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