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Rising inequality is often attributed to the “neoliberal model”. And indeed, wage equality does not easily fit the liberal objectives of fiscal discipline and high levels of employment. What is the liberal way out of the “trilemma”?
By Tom Papworth
Politicians of all persuasions are increasingly worried about rising income inequality and the extent to which growth is failing to benefit everybody within the economy. The concept of “inclusive growth” is built on a belief that growth should be “shared”, “pro-poor”, “broad-based across sectors” and “inclusive of the large part of the country’s labor force” (World Bank 2009). This presents particular challenges for liberals. Firstly, liberalism takes a generally positive view of economic growth, seeing it as a widely beneficial process emerging from the mutual gains from trade that result when individuals, guided by (enlightened) self-interest, collaborate and exchange. Narratives that suggest that growthcould be harmful to marginalised groups, or even that some groups could simply be left behind, are therefore disturbing for liberals. Secondly, typical responses to what might be termed “exclusive growth” tend to emanate from a familiar list of illiberal, anti-market, protectionist interventionists from both conservative and socialist traditions. Recommended responses tend to include punitive taxation, maximum wage legislation and even public ownership of whole industries, as well as more general opposition to trade, immigration and market relations.
This article will consider the challenges facing modern, developed economies, building on the analysis of Iversen and Wren (1998). They arguethat service-sector economies struggle to create sufficient high-wage service sector jobs, and that as a consequence they face a trilemma; governments are able to achieve up to two, but not all three, of the competing aims of job growth, income equality and budgetary restraint.
Explanations for changes in employment, equality and fiscal conditions in the late twentieth century have usually centred on the impact of globalisation. However, globalisation primarily impacts the traded sector of the economy, which to a large extent is synonymous with manufacturing. In developed economies, the significance of manufacturing has fallen dramatically over the past half century. Figure 1 reproduces a chart from Pilat et al. (2006) showing the decline in the proportion of jobs in manufacturing in G7 countries. Every G7 country has seen a dramatic fall in the contribution that manufacturing makes to employment. This decline represents a combination of two factors: an absolute decline in the number of manufacturing workers in most OECD countries, and rapid employment growth in the services sector (Wölfl 2005).
It is important to note that this decline in manufacturing employment
has not been accompanied by a fall in manufacturing output.
In the UK, for example, output grew by about a quarter over the 25 years from 1980 despite a near halving of manufacturing employment. The key to this is the rising productivity of industrial workers, which has been aided by technological improvements/ innovation. However, as Iversen and Wren (1998) describe the process, increased output leads eventually to market saturation and a shift of demand towards quality rather than quantity – rather than consumers demanding more
manufactured goods, they demand better
goods. They also increasingly shift demand to services. But as Baumol and Bowen (1966) argued, increasing productivity in the service sector is not nearly as easy. Many service sector jobs are resistant to productivity growth: innovation cannot increase the number of haircuts a barber can provide, or increase the rate at which care nurses help old people in and out of bed. Consequently, as economies become more service intensive it becomes harder to achieve the virtuous circle of increasing wages and prices. Real demand is increased only by reducing costs in the provision of services.
Thus increasing employment in the service sector is achieved only through creating additional, low-paid service sector jobs, which increases inequality. Conversely, wage equality is generally achieved through keeping unproductive workers out of employment altogether. For example, Belgium, Ireland, France, Luxembourg and Norway had the highest productivity levels in the OECD area in 2004, with levels at or above those of the United States (OECD, 2005). Yet all except Norway also had employment rates well below that of the us and indeed below the OECD average (OECD, undated).
Public sector jobs
Governments have traditionally tried to square the circle through creating substantial numbers of relatively well-paid service sector jobs in the public sector. However, this has an inevitable impact upon the public finances. For example, the New Labour government in the UK increased public sector employment by 15.7% between 1997 and 2010 (Bach and Stroleny 2012) and the general government pay bill grew by 4–6% per annum in real terms from 1998 to 2006 (Bozio and Johnson 2010). Yet productivity in the public sector remained flat (Massey and Caul 2014) and from 2001 the UK ran a public sector deficit that meant that it underperformed comparable countries in a period when public sector debt was falling among most leading industrial nations (Chote et al 2010).
Iversen and Wren (1998) argue that the governments of modern, industrialised economies are therefore caught in a trilemma: they cannot achieve the three objectives of high employment,income equality and fiscal restraint simultaneously.
- The Neoliberal Model looks to maximise employment growth while maintaining fiscal discipline, which is achieved through liberal market policies such as flexible labour markets and low or no minimum wage. Labour market participation is high, but low-skilled workers are locked in poorly paid jobs with few prospects for advancement, and so inequality is high.
- The Christian Democratic Model combines high wage employment and fiscal discipline though fiscal restraint and inflexible labour markets. High levels of job security incentivises employees to train and improve their productivity. This raises wages but limits job creation, thus locking low-skilled workers out of the workforce and creating insider-outsider conflict. Put simply, wage equality is achieved by preventing the low-skilled from earning a wage at all. In particular, this tends to equate to low levels of female labour market participation and high youth unemployment.
- The Social Democratic Model combines high levels of job creation with high wages through expanding the public sector. This enables relatively high levels of income equality both through providing generous pay to (often low skilled) service-sector workers and through taxing away the gains of highly productive, high-income workers. This also creates insider- outsider conflict – in this case, between highly taxed private sector workers and highly remunerated public sector workers – and leads to tax revolts, inefficiency and government failure in the socialised service sector, poor competitiveness and to unsustainable budget deficits.
We should note that the above models are three ideal types, and that countries are able to adopt middling positions. Thus (for example) a highly Christian Democratic country could generate some employment growth at the expense of sacrificing some income equality or fiscal discipline. This is arguably the approach that was adopted by Germany with the Hartz reforms, which allowed the creation of “mini-jobs” that offered low wages, short employment duration, were exempt from social security, and were treated differently in income tax law. This led to the creation of large numbers of jobs but has also been accompanied by widening income inequality (Marsh and Hansen 2012).
This trilemma presents a major challenge for governments in developed economies. But it also presents a challenge to critiques of “neoliberalism”. Typical objections focus on rising inequality, but it is at least questionable whether wage inequality is a worse social challenge than high levels of unemployment, low female labour participation rates, insider-outsider conflicts, inefficiënt publically-owned services or unsustainable fiscal deficits. While “inclusive growth” is almost axiomatically a good thing, we should be wary of assuming that egalitarian policy prescriptions will lead to better overall social outcomes. There is also a possibility that liberals may be able to find a solution to the trilemma, at least in the long term. Iversen and Wren (1998) themselves note in conclusion that: “the severity of the trilemma depends on the continued inability to increase productivity in the services sector. Increases in services productivity would allow prices to fall and wages to rise simultaneously, as in the golden age of manufacturing.”
While it may be true that many service sector jobs are resistant to productivity increases, it does not follow that individuals need to be trapped in these jobs. The route out of the trilemma must surely depend upon upskilling the workforce and so providing an expansion of highly skilled service sector jobs, potentially accompanied by an automation of low-skilled service jobs akin to the automation of so many manufacturing jobs in the previous century. While this solution is not quick, and it may not be possible to provide this escape for many of those currently in work, there is a strong case for concentrating public policy effort on developing a highly skilled future workforce.
is Associate Director for Economic Policy at CentreForum, the UK’s liberal think tank.
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