15 July 2021
Rethinking Government’s Role
Olivier Blanchard and Dani Rodrik
2021, MIT Press, 312 pages,
Reviewer: Christine Shields
In a very fragmented but wide-ranging survey of economic inequality, the editors present twenty nine individual tracts aimed at framing the challenge and then addressing how to deal with it.
In a persuasive introduction, the editors give a global overview and cite the sharper rise in inequality in the past five decades in the US compared with Europe. Strikingly, the wealth share of the top 1% in the US has leapt from 25% in the 1970s to 40% now, while social mobility has fallen back. Policy has focused more on poverty reduction than on this widening gap, despite a growing consensus that it is unhelpful and needs to be directly and urgently fixed given the social consequences.
Usefully starting with a description of the scale of the problem, the first section points to the lack of good data and to the fact that rich countries may have become richer but their governments have become poorer. Basically tax revenue is not enough and public investment is the casualty. This has implications for the levelling up agenda – a lesson perhaps for the UK government.
A short piece on the philosophy of inequality covers the links between economic fairness and social equality via political fairness and morality. This is followed by a discussion of what exactly should be targeted by policy – domestic versus global, snapshot versus lifetime income or outcome versus opportunity. This latter question finds this source of inequality arguably less objectionable as it reflects the element of luck and ‘right place, right time’ that benefits some. This aspect is explored further by addressing why inequality matters and pointing to the unacceptability of institutional unfairness and unequal opportunity.
Clearly these issues have massive political dimensions and are currently driving growing polarisation, both in the US and the UK. Wealth inequality tends to be the focus rather than income inequality, yet few fully appreciate the scale of their wealth. How can a pension be valued, for instance? Or good health? Or for that matter, a clean environment? Concentrating on housing wealth, and looking at the UK and Denmark, housing market health is found to drive anti-populist tendencies when house prices are rising and populist tendencies when falling. The ‘haves and have nots’ that have given rise to sentiment in the so-called Red Wall in the North of England?
But the rightward shift in the 1980s and 1990s of leftist parties moved them away from policies stressing economic issues and class identities towards social issues. Ironically, this has made it harder to generate a sustained campaign to combat inequality. Looking specifically at the US, the sharp rightward shift of the Republican Party is in part a reflection of the systemic reliance there on wealthy donors for party funding. While the Democrats have moved relatively less leftwards than many feared, the perception of that shift – and the stubbornness of some Republicans - impedes any bi-partisan approach to dealing with inequality.
Moving on to the need for a comprehensive safety net, the authors point to four basic principles required for the US: a child allowance to enable them to succeed; in-work support that means work pays enough to live on; some protection to cushion the impact of job loss; and a safety net for those unable to work. Some element of all these exist now but in a patchy and piecemeal fashion, and improvement is required. Strengthening worker bargaining power may be a route towards this. Improvements in education would be another way of levelling.
In terms of economic policy, the shift of global manufacturing to China has exposed flaws in the US economy. Hardest hit by the China shock has been US labour-intensive manufacturing, especially those workers less educated or skilled, many in the South. This has brought about regional income divergences – and arguably helped create the ‘Trump constituency’. While these flaws were not created by the China shock, it did exacerbate them, especially because of the speed of demise of US manufacturing. Existing policies to alleviate the impact – the Trade Adjustment Assistance programme – have helped by providing temporary income support as well as retraining. But more is needed – and urgently.
A very interesting piece compares the US experience of the China shock with that of Germany. Germany experienced a twin shock – increased imports from Eastern Europe as well as from lower-cost China. But Germany benefited from both aspects. Essentially, the import surge allowed China and Eastern Europe to fund German exports so Germany had a positive export shock that offset the negative import shock – and it had a trade surplus while the US had a hefty deficit. This in part reflects German industrial structure, biased towards capital and high-end good exports. The flexibility of its industry helped – elsewhere in Europe, more rigid regulatory set-ups struggled. Better industrial relations were another factor, as was the willingness of German workers to reskill, helped by their excellent apprenticeship system. There are lessons here for the UK.
One school of thought blames the very fact of running a trade deficit for the severity of the impact of the China shock. But relatively weak secondary education is another factor, as is a focus on the growing financial sector which disproportionately impacted both the US and the UK.
Continuing the financial theme, discussion then moves to taxation. But should a paternalistic wealthy person pay the same tax as his selfishly spendthrift equivalent? Would taxing wealth anyway reduce inequality? What would that do for the political influence of the rich? Larry Summers’ contribution examines the pros and cons of wealth taxes and concludes that improving general tax compliance and simplifying the system is a better route which also makes raising tax rates more feasible. But even if there was a wealth tax, what should the revenues raised be used for? If promoting longer-term improvement such as infrastructure or education, the capital stock may be built up. But potentially entrepreneurism could be discouraged.
Has automation added to inequality? Of course it brings some social costs. Changing the tax system so that labour is treated more favourably than machinery might help. More government investment in high-tech R&D would also help offset the dominance of the huge technology companies such as Google. But the technology revolution has brought wider benefits across all sectors. Where it is undesirable is the tendency towards monopoly power that outdoes even the government. How best to tax this area is not explored. Innovation is seen as desirable, yet is itself a cause of inequality by creating winners and losers. ‘Twas ever thus sadly. Laura D’Andrea Tyson suggests some policy responses to this issue: essentially rebalance US labour relations and corporate governance away from employers more towards workers.
A brief sally into gender inequality is followed by a discussion on changing ownership structures and then implementing a federal job guarantee. Most interesting to me in this section was the piece by DT Ellwood on Making Work Work. At the lower end of the earnings spectrum, pay levels have stagnated, more so for women than men. But by 2018, the median male earned no more than his equivalent 45 years before. So sons no longer earn more than their fathers and hard work no longer pays for all. Tax credits are one solution, as is raising the status – and pay – of some workers such as those in social care. Raising skills is another idea but of course does not eliminate the need for some unskilled roles.
Another common-sense section looks at worker exploitation. Clearly better enforcement of labour market policies is the answer. There is no point in having a minimum wage if employers can find ways around the system by, for instance, making workers clock out and then clean up. This is followed by a piece on improving social safety nets. Though most industrialised countries have something, the US has relatively weaker automatic stabilisers in its system than most of Europe.
To conclude, the source of tax revenues is discussed. Neither VAT nor payroll tax – on which most advanced economies rely for the bulk of their revenues – are especially progressive. The US will probably have to introduce a nationwide VAT at some point. Better for fairness though would be changes to capital gains tax. More and stronger evidence would help to make a case for that, but capital and wealth are typically opaque. And asymmetric in that the rich are better placed to evade/avoid tax.
So would a wealth tax work? The US tax system is currently pretty flat – all social groups pay some 28% except for the 400 richest who pay just 23%. If their wealth of over $50 million were taxed at 2% and over $1 billion 3%, those 400 would pay an effective tax rate of 46%. This was, of course, the Elizabeth Warren proposal. But wealth is mobile as the 1970s UK experience proved. Enforcing a wealth tax would be a challenge, especially given its political aspect and the complications of party funding. This is a complex issue that sadly this series of pieces fails really to progress. So we can expect more books of this theme to come.