Return to normal programing – or growth - won’t solve equity problem

Polling day - and the long, subsequent counting days -  has passed in the US Presidential election and President-elect Joe Biden has vowed to govern for all Americans. But the divisions in US society will remain - not least along the fault lines of wealth and income disparity.

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These disparities, however, go beyond the disunited states - they are genuinely global challenges.

"A pre-COVID problem was not just the existence of historically slow economic growth in many economies but how that growth was distributed.” 

The way economists account for growth is well known. Gross domestic product (GDP) growth equals growth in inputs plus productivity. Improving productivity through reform is often spoken of as the path to returning to, and sustaining, stronger economic growth.

Certainly, growth that creates more jobs will help reduce inequality. But beyond that, the ability to just strive for growth while ignoring equity issues gets much cloudier.

The step-shift in inequality this year has been eye watering. Even if a vaccine for COVID-19 is widely available in 2021, as seems more likely, social distancing, restrictions on movement and other constraints will likely still be required in most economies.

COVID-normal is unlikely to see inequality decrease with any speed given those constraints hit the less well-off harder.

Movement restrictions, particularly on immigration, are likely to constrain top-line GDP growth for quite some time. This is in addition to the long-lived drivers of secular stagnation, including aging populations, high debt and increased distrust between countries. Addressing these structural issues is only becoming more pressing.

The right hands

A pre-COVID problem was not just the existence of historically slow economic growth in many economies but how that growth was distributed.

Superstar firms, technology companies, some natural resource companies and even some of the super-rich have been winners from the global growth of the last one or two decades. But median wages in many economies have not increased the way economists might have expected and certainly not in a way that was consistent with historical experience.

Even if structural reform is able to restore a stronger growth path, there doesn’t seem to be any obvious reason for the distribution of income gains to improve. For one, the COVID-19 crisis has supercharged the shift to digital.

A McKinsey survey suggests digital adoption is now about 25 times faster than before the pandemic. The use of robotics has also taken a leap forward. The export of robots from Japan, the world’s largest exporter, rose 13 per cent year-on-year in the June quarter, at a time when global trade was in recession. Robots are now attractive for business continuity as well as for efficiency.

Consider also the globalisation of labour has often been considered as a mostly manufacturing phenomenon. Yet white-collar workers have benefitted most from flexible working in this pandemic. Not living near the office could extend to not even living in the same country.

Will it even work?

It is not even a given that reform can generate materially stronger growth. If it doesn’t, even the reduction in unemployment might be wanting.

For emerging economies, where there is plenty of low-hanging fruit, reform can drive meaningful changes in the underlying economic growth rate. For advanced economies with mature levels of debt, that is harder. Try to think of an advanced economy that has “reformed” its way to much-faster growth. The list is thin, very thin.

Of the advanced economies, Europe has perhaps had the most reason in the last decade to find growth through reform. The European Central Bank (ECB) suggests estimations of the short- and medium-term impact of structural reforms on GDP growth are “methodologically problematic and still highly controversial” and concludes benefits “tended to materialise earlier, but overall to be more limited, in advanced economies than in emerging markets”.

One reason, I suspect, is the role of credit is under-represented in the traditional framework. Reforms raise potential growth a bit but they raise confidence in borrowing as well. And it’s the borrowing that brings much of the future reform dividend into the present. The problem then is higher levels of debt challenge future growth.

Inequality breeds vulnerabilty

Stronger growth doesn’t necessarily do much to reduce inequality beyond creating some jobs but inequality can actually threaten the foundation of growth. Those on higher incomes almost universally save more but those on lower incomes tend to borrow more.

Inequality, in other words, tends to exacerbate financial vulnerabilities.

The Federal Reserve Bank of San Francisco found rapid growth in the income share of the top 10 per cent of earners and prolonged low labour-productivity growth are in fact robust predictors of financial crises.

The bottom line

Inequality may well be the biggest policy challenge after the COVID-19 pandemic comes to an end. Striving for better top-line GDP growth will appeal to some as the best way to address the challenge but that approach is likely to be frustrated.

Given those on lower incomes tend to spend more, where the growth ends up also matters for, well, the growth. Less-standard policies require consideration, including those focused on reducing the structural sources of high inequality.

Richard Yetsenga is Chief Economist at ANZ

This article is based off a piece originally published on ANZ's Institutional website

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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