Income distribution: Encouraging work

Some policies are economically illiterate, for they cause avoidable inefficiency. Others are heartless, for they cause avoidable human suffering. Few policies manage to be economically illiterate and heartless all at once. But Britain’s Conservative government has achieved just that, by cutting tax credits for low-income workers.

The system, introduced in 2003 by a Labour government, is modeled after the United States’ Earned Income Tax Credit. Both work in practice like a wage subsidy for those with low incomes, cutting poverty – particularly among women with young children – while strengthening incentives to work. Success has attracted emulators. Turkey adopted regionally targeted employment subsidies in 2004-2005. When I was Chile’s finance minister, our center-left government adopted a wage subsidy in 2008, focused on young workers. South Africa’s government did much the same in 2014. Other middle-income countries have discussed adopting similar policies.

Out of today’s five billion working-age people, only three billion have jobs. Solving that problem will require fresher thinking than experts and politicians have provided so far. Osborne and the British Tories got it completely wrong

The Tory move in the United Kingdom is based on shortsighted fiscal calculations (appearing to shave additional pounds from the budget deficit) and shortsighted political calculations (displaying “toughness” to right-wing voters who believe that the poor are undeserving). But the move is also interesting in terms of what it reveals about the coming debate on the role of work (and of labor-market policies) in both advanced and emerging economies.

Two forces are shaping this debate. The first is technological change. After globalization made it easier to move manufacturing and service jobs from rich to poor countries, growing automation now threatens to move jobs from humans to robots. A recent paper by two Oxford University economists estimates that up to 47% of all jobs in the US are at risk.

Fears about job losses arising from technological progress are not new. The nineteenth-century Luddites fretted over that. Inventions like the steam engine and the power loom destroyed some jobs but eventually created many more.

But there are caveats. One is that adjustment is lengthy, because old jobs go quickly but new ones can take a long time to replace them. Public policies are needed both to accelerate the process and to alleviate human suffering.

Another caveat is that technological change may worsen the income distribution if the jobs that are destroyed are those filled by unskilled workers. Less demand for their services will cause their relative (and perhaps absolute) wages to drop, causing income inequality to rise. Again, activist policy is called for, and here schemes like wage subsidies can play a key role. Unfortunately, the acrimonious politics surrounding today’s jobs debate makes crafting the right policy response difficult. In rich countries, the stagnation of middle-class wages has caused understandable anxiety. Politicians like Hillary Clinton in the United States are promising that they can cajole large corporations into paying higher wages.

Politics is heating up in middle-income countries as well, and unions are pressing politicians to take action. Consider Chile, where the current leftist government has sent a bill to Congress that promises to improve income distribution simply by giving unions more power in collective bargaining.

The aims are lofty, but the proposed policies alone will not solve the problem. Limited minimum-wage increases in a growing economy need not cost jobs; but sizeable increases in a context of slumping growth (the norm nearly everywhere today) surely will. And automation will make it easier to substitute machines for workers, likely undermining the low elasticity of labor demand with respect to the cost of hiring (adjusted to include turnover and training costs) that underlies the Card-Krueger-Krugman view. Similarly, the potential for union-led bargaining to redistribute income presupposes non-competitive corporate practices, which in turn generate abnormal profits that can be bargained away by unions. But globalization and technological progress, by making it easier to match supply and demand, will make such monopolistic behavior harder to maintain in the future.

We are accustomed to the idea that owners of capital hire laborers and set the rules. In the future, technology may enable laborers to hire the capital they need and work with an unprecedented degree of autonomy. Distributional struggles will look very different in that kind of world. Last month, I attended a conference in France entitled “What if work were the key?” The attendees – France’s best and brightest – resoundingly concluded that work does seem to be the key to enhancing social cohesion, and to more fulfilling lives.

The attendees also agreed that the best way to improve income distribution is to provide work to those who have no job (and therefore no income). One figure mentioned at the conference stuck out: Out of today’s five billion working-age people, only three billion have jobs. Solving that problem will require fresher thinking than

experts and politicians have provided so far. Osborne and the British Tories got it completely wrong. Others should ignore their example.

Velasco is Professor of Professional Practice in International Development at Columbia University.

© Project Syndicate, 2015